Where Is Investment Interest Expense Deductible?
In a bizarre disagreement among colleagues, the Manual disputes the position taken by the IRS forms- writing division on the treatment of investment interest expense. In any hedge fund, the investors, whether limited partners or nonmanaging members, do not actively participate in the fund’s management. As a result, interest expense allocated to them is investment interest under Section 163(d). There is, however, no regulation or similar guidance from IRS Chief Counsel to that effect. Form 4952 (dealing with investment interest) instructs the taxpayer–for any interest attributable to a trade or business in which the taxpayer did not materially participate and is not a passive activity–to “enter that part of the interest expense on the schedule where you report other expenses for that trade or business.” Thus, the taxpayer is instructed to report the interest on Schedule E as business interest, deductible under Section 162, and not as investment interest. The Manual disputes the instru
