7948 / Can a shareholder deduct the interest paid on a loan used to purchase mutual fund shares?

A shareholder may not deduct interest on indebtedness incurred or continued to purchase or carry shares of a mutual fund to the extent that the company distributed exempt-interest dividends to the shareholder during the year.² The amount of interest disallowed is the amount that bears the same ratio to total interest paid on the indebtedness for the year as the exempt-interest dividends bear to exempt interest and taxable dividends received by the shareholder (excluding capital gains dividends).³

In determining whether the indebtedness was “incurred or continued to purchase or carry” shares, one should be able to look to interpretations of comparable language with respect to deductions for interest on “indebtedness incurred or continued to purchase or carry” certain other property (see, for example, Q 8044).⁴ For purposes of determining whether interest is investment interest, temporary regulations provide complex rules under which interest expense is allocated on the basis of the use of the proceeds of the underlying debt (see Q 8043).