8045 / Is interest paid on amounts borrowed to purchase or carry Treasury bills or short-term taxable corporate obligations deductible?

Where indebtedness is incurred or continued by a cash basis investor to purchase or carry Treasury bills, other short-term taxable government obligations, or taxable corporate short-term obligations (i.e., obligations with a fixed maturity date not more than one year from the date of issue), the current deductibility of interest expenses will be subject to limitation and deferral. However, if the taxpayer is required to or elects to include interest and acquisition discount or original issue discount as it accrues (as discussed in Q 7625, Q 7627), the otherwise allowable deduction of interest will not be limited or deferred except by any limit on deductibility applicable under the interest tracing rules (see Q 8043).¹

If the taxpayer does not include discount and interest as it accrues, the deductibility of interest expense incurred to purchase or carry the obligation is subject to certain limitations. Such interest will be deductible to the extent of includable interest income from the obligation. Interest expenses in excess of that amount will be deductible only to the extent that the interest expense exceeds the total amount of discount and interest accrued (but not includable) while the taxpayer held the bond during the year.² Thus, the excess interest expense that is equal to the discount and interest accruing in the year (but is not currently includable in income) is not currently deductible. The deduction is deferred to a later year when includable interest income on the obligation exceeds interest expense for the year, or to the year of disposition.³

In the case of short sales of securities, expenses that are not required to be capitalized (see Q 7529, Q 7530) are treated as interest expenses subject to these limitation and deferral rules if the proceeds of the short sale are used to purchase or carry Treasury bills or other taxable short-term government or corporate obligations.⁴

Whether amounts are borrowed or are loans continued to purchase or carry short-term obligations depends on the taxpayer’s purpose for borrowing. In determining the individual’s purpose, the IRS will, apparently, apply the same principles applied in determining if indebtedness is incurred or continued to purchase or carry tax-exempt bonds (see Q 8044).