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Interest not deducted due to limit
In the year you dispose of the bond, you can deduct the amount of any interest expense you were not allowed to deduct in earlier years because of the limit.

Choosing to deduct disallowed interest expense before the year of disposition. You can choose to deduct disallowed interest expense in any year before the year you dispose of the bond, up to your net interest income from the bond during the year. The rest of the disallowed interest expense remains deductible in the year you dispose of the bond.

Net interest income - This is the interest income (including OID) from the bond that you include in income for the year, minus the interest expense paid or accrued during the year to purchase or carry the bond.

Limit on interest deduction for short-term obligations - If the current income inclusion rules do not apply to you, the amount you can deduct for interest expense you paid or accrued during the year to buy or carry a short-term obligation is limited.

The interest is deductible only to the extent it is more than:

• The amount of acquisition discount or OID on the obligation for the tax year, plus
• The amount of any interest payable on the obligation for the year that is not included in income because of your accounting method (other than interest taken into account in determining the amount of acquisition discount or OID).

The method of determining acquisition discount and OID for short-term obligations is discussed in chapter 1 of IRS Publication 550 under Discount on Short-Term Obligations.

Interest not deducted due to limit - In the year you dispose of the obligation, or if you choose, in another year in which you have net interest income from the obligation, you can deduct the amount of any interest expense you were not allowed to deduct for an earlier year because of the limit. Follow the same rules provided in the earlier discussion under Limit on interest deduction for market discount bonds, earlier.

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Back to: Investment Interest Expense Index

Other sections to read about investment interest expense: Investment Interest Expense, Investment Interest General Information, Allocation of Interest Expense, When to Deduct Interest Expense, Form 4954 Guidelines, Investment Income of Children, Limits on Investment Interest Deduction, Investment Expenses