8707 / In calculating the allowable investment interest deduction, what are the tax consequences when a taxpayer elects to treat all or a portion of capital gain or qualified dividend income as investment income?
Net investment income, for purposes of the interest expense deduction, generally does not include net capital gain from the disposition of investment property or qualified dividend income unless the taxpayer elects to treat this income as investment income. See Q 8705.
If the taxpayer makes this election, any net capital gain or qualified dividend income treated as investment income is not eligible to be taxed at the capital gains rates and will be subject to the taxpayer’s ordinary income tax rate for that tax year, rather than the special lower tax rates that otherwise apply to these types of income (see Q 8605 for a discussion of the currently applicable tax rates for capital gains and qualified dividend income).1
The advantage of making the election is that a taxpayer may increase the amount of investment income against which investment interest is deducted, thus receiving the full benefit of the deduction.2