Deduction for Investment Fees and Expenses
The new tax law suspends or limits a number of popular
deductions, including the miscellaneous itemized deduction
for investment fees and expenses. For tax years 2018
through 2025, you will not be able to claim a deduction for
investment fees and expenses.
Net Investment Income Tax
Individuals, estates, and trusts with income above certain
thresholds are subject to an additional 3.8% tax—also known
as the “net investment income tax” or “NIIT”—on their net
investment income. Net investment income includes:
Most interest, dividends, annuities, royalties, and rents
Income from the business of trading in financial
instruments and commodities (trading business)
Income from a trade or business that is a passive
activity as defined in the Internal Revenue Code
Net gain from the sale of all property other than
property held in a trade or business in which the owner
materially participates (other than a trading business).
Properly allocable expenses and losses that are allowed
as a deduction for income tax reduce the amount of net
investment income. The tax on net investment income is
not subject to withholding, but is subject to the estimated
Certain income and gain are excluded from net investment
income. Excluded income includes:
Income from self-employment that is subject to selfemployment (SECA) tax
Wages that are subject to federal payroll (FICA) tax
Income that is exempt from income tax (such as
municipal bond interest)
Income of nonresident aliens
Distributions from qualified plans
Income and gain from a trade or business in which the
owner materially participates.
Generally, portfolio income and passive investment-type
income are included as net investment income, but if an individual, estate,
or trust is sufficiently involved in the
operations of a trade or business, the income and gain from
that business is generally excluded from net investment
income even if it is not otherwise subject to SECA or FICA
If you or your S corporation or partnership owns portfolio
investments such as stock in a C corporation or debt
securities, your share of the income from the investments
and gain or loss on sale of the investment assets is net
If you own rental property, the rents and gain on sale are
generally net investment income. There are very limited
exceptions under the passive loss rules that may result in
exclusion of some rental income and gain on sale of rental
assets from net investment income
Income and gain from stock in a controlled foreign
corporation (CFC) and a passive foreign investment
company (PFIC) will generally be included in net investment
income, but the timing of the inclusion may vary from the
general rules applicable to CFCs and PFICs.
If you own a trade or business directly or through
an S corporation or a partnership, your income
and gain on the sale of the business assets are
net investment income unless you materially
participate in the trade or business under the
passive activity rules. Consider grouping your
trades or businesses, and see the discussion
below under Understanding passive activity rules.
Be sure to consider the tax on your net investment
income when making estimated tax payments.
Gains and Losses From the Sale of Capital Assets
Almost everything you own and use for investment and
for personal purposes (i.e., not for trade or business) is a
capital asset. For example, if you own shares in Company
X, those shares are capital assets. If you were to sell those
shares (or any other capital asset), the resulting gain or loss
from the sale would be either a capital gain or capital loss.
A capital gain occurs when you sell a capital asset for more
than its basis (generally, the cost of the asset), and a capital
loss occurs when you sell a capital asset for less than its
basis. If you purchased 500 shares of Company X for $1
per share, your basis in each share would be $1. If you
were to sell those 500 shares for $2 per share, the $500 in
“profit” from the sale would be a capital gain. Alternatively,
if you sold those same 500 shares for $0.50 per share, the
$250 loss would be a capital loss.
Capital gains and capital losses are either short-term or
long-term, depending upon the length of time you held the
capital asset prior to selling it. A capital gain or loss is
short-term if you held the capital asset for a year or less.
If you have held an asset for more than a year, then any
capital gain or loss would be long-term.
Whether a capital gain or loss is classified as short-term or
long-term can have significant tax implications. Whereas
a short-term capital gain is taxed as ordinary income, a
long-term capital gain is taxed at a preferential rate lower
than your ordinary income tax rate. Long-term capital gains
are subject to tax at either 0%, 15%, or 20% depending
upon your filing status and taxable income. See the table in
"Current Tax Rates"
for the income levels at which the different
long term capital gain rates apply.
If you sold multiple capital assets during the course of a tax
year, it is likely that some of your transactions resulted in
losses, and others in gains, and that some of these gains or
losses were short-term, while others were long-term.
To determine the tax impact of your capital transactions, you
must net your short-term gains against your short-term losses
and your long-term gains against your long-term losses.
If you have both a net short-term gain and a net
The short-term gain is taxed as ordinary income
The long-term gain will be taxed at a preferential rate
If you have both a net short-term loss and a net
You can deduct up to $3,000 ($1,500 if married filing
separately) on your tax return.
If your total loss is more than $3,000 ($1,500 if married
filing separately), the excess loss can be carried over to
the next year.
If you have a short-term loss and a long-term gain, net the
If the gain is bigger than the loss, you have a long-term
gain, which is taxed at the preferential rate.
If the loss is bigger, you have a net short-term loss, of
which you can deduct up to $3,000 ($1,500 if married
filing separately) and carry forward any excess to the
next year as short-term loss.
If you have a short-term gain and long-term loss, net the
If the gain is bigger than the loss, you have a short-term
gain, which is taxed at your marginal rate.
If the loss is bigger, you have a long-term loss, of which
you can deduct up to $3,000 ($1,500 if married filing
separately), and carry forward any excess to the next
year as long-term loss.
If you purchased all 500 shares of Company X stock at
the same time and sold them all at the same time, then
determining whether you have a capital gain or capital loss
and whether your gain/loss is short-term or long-term is
straightforward. But what if you purchased half the shares
January 1 of last tax year for $1, and the other half January
1 of the current tax year for $2, and sold 100 shares today
for $1.50? How do you determine whether you had a gain
or loss on the sale, and whether that gain or loss was
long-term or short-term? That all depends upon the cost
basis method you tell your broker to use.
Each time you purchase shares of stock (regardless of the
number of shares you purchase or the amount of time in
between purchases), your broker assigns your purchase
a unique tax lot ID. When you sell shares of stock, your
broker uses this tax lot ID to determine the basis of the
sale. This determination is often based upon the default
cost basis method used by your broker. By default, most
brokers use the FIFO (first-in, first-out) cost basis method,
which means that the oldest shares are treated as being
sold first. If, in the above example, your broker employed
the FIFO cost basis method, 100 of the 250 shares of
stock in Company X that you purchased for $1 would have
been sold for $1.50, resulting in a long-term capital gain of
$50. However, you are not limited to the default cost basis
method selected by your broker. You may instruct your
broker to use an alternative cost basis method or select
specific tax lots to sell. In this way, you can exercise a large
degree of control over your yearly short-and long-term
capital gains and losses.
Determine your capital gain and loss
carryforwards to ensure you are aligning them to
the fullest extent possible.
Consider selling assets in taxable accounts
that have losses at the end of the year to offset
capital gains, and potentially offset $3,000 of
Consult your tax adviser to determine which
cost basis method optimizes your capital gains
is discussed in its own section.
Exchanging Properties of Like Kind
In 2017, it was possible to defer paying tax on gain realized
on the disposition of certain property by arranging the
transactions as an exchange. Rather than selling your
property and reinvesting the proceeds in new property,
you were able to “exchange” your property for property
of a “like kind” within certain time limits. If you met the
requirements for such a like-kind exchange, the gain or loss
on the disposition of your old property was deferred until
you sold the new property in the future.
The new tax law effective for 2018 limits the like-kind
exchange rules to exchanges of real property (other
than real property held primarily for sale). The new law’s
limitation on like-kind exchanges eliminates deferral for
exchanges of tangible personal property and intangible
property. However, a transition rule provides that the new
law does not apply to any exchange in which you disposed
of relinquished property, or received replacement property,
on or before December 31, 2017
Although like-kind exchanges offer many advantages,
numerous requirements must be met before an exchange
can qualify for tax-free treatment. Here are just a few:
Both the real property you dispose of and the real
property you acquire must be held by you for productive
use in a trade or business or for investment.
For transactions initiated after December 31, 2017, the
like-kind exchange rules are applicable only to real property,
other than real property held primarily for sale. Prior to
January 1, 2018, certain property, other than real property,
was also eligible for like-kind exchange treatment.
You must not have actual or constructive receipt of
the sales proceeds or any discretionary control over
those proceeds during the transaction. It is extremely
important to have an airtight written escrow agreement
that includes certain restrictions on you for the
transaction to qualify as an exchange of property
The expected replacement property must be specifically
identified in writing within 45 days after the date on
which you sell the first property to be disposed of in the
exchange. Certain limitations apply as to the properties
that may be identified.
You must acquire the identified replacement property no
later than 180 days after the date you disposed of the
first property in the exchange or the due date (including
extensions) of your tax return for the year in which the
transfer of the first property occurred, whichever
Special considerations apply if an exchange involves
related parties. For example, if you swap properties
directly with someone related to you, both of you
generally must retain the exchanged properties for at
least two years. If either property is transferred within
two years, you must recognize any gain you deferred on
the swap, unless the second transfer occurs because
of death or involuntary conversion, or if both transfers
qualify as non-tax-avoidance transactions. In addition,
you generally may not purchase replacement property
from a related party for cash in an exchange.
Many special rules apply in a like-kind exchange, and
not all real property is eligible for deferral. As a result, you
should consult your tax adviser before entering into such
Exchanges of like-kind property are not limited to
transactions directly between two parties. If you
cannot reach agreement with an exchange candidate,
you may benefit from a multi-party exchange—that
is, a transaction in which you dispose of your real
property to one person and acquire your new real
property from someone else. This option may be
a possible solution that may satisfy all parties’
objectives and still allow you to achieve tax deferral.
The “at-risk” rules limit your deductible losses to the
amount for which you are economically at risk, that is, the
amount you could actually lose in a trade or business or a
for-profit activity. The rules on what constitutes an activity
for at-risk purposes differ and are more restrictive than
similar rules under the passive activity loss provisions.
Generally, each trade or business activity is treated as
separate for purposes of the at-risk rules, with limited
exceptions for certain activities conducted through
The at-risk amount generally includes the cash and
adjusted basis of property you contributed to, and the
amount you paid for an interest in, the business or for-profit
activity. This includes amounts borrowed for use in the
activity, but only to the extent you are personally liable for
repayment. For example, if you make a loan to the activity
or are personally liable through an enforceable guaranty of
debt incurred by the business (for which you have no right
to reimbursement), your at-risk amount is increased by
the amount of the debt and the amount of the guaranty.
In addition, there is a special rule that allows inclusion of
“qualified nonrecourse financing” in your at-risk amount for
real estate activities.
The at-risk amount is increased by income and gain
recognized and is decreased by losses and distributions.
At the end of the year, if you do not have a positive at-risk
amount, deductions or losses generated by the business or
for-profit activity are suspended. In addition, if your
at-risk amount is less than zero because of distributions,
the rules require you to “recapture” (include in gross
income) a portion of previously allowed deductions.
Finally, when you dispose of the activity, any gain
recognized will increase the at-risk amount and allow use
of suspended losses to that extent.
The at-risk rules apply to individuals, trusts, estates, and
certain closely held C corporations. If a loss or deduction
is suspended under the at-risk rules, the loss or deduction
cannot be used for any purpose in that tax year.
Once the loss or deduction is allowed under the at-risk
rules, however, then the rules relating to passive activities
(described below) are applied to determine whether
you can obtain the benefit of the loss or deduction for
Individuals should maintain records of the amount
they have at risk in each of their business and for-profit
activities to avoid unexpected recapture and to allow
use of losses and deductions incurred in the activity.
If the at-risk amount approaches zero, consider ways
to increase the amount at risk and weigh that against
the possible economic exposure involved in personal
liability on a loan or a guaranty of debt.
Understanding Passive Activity Rules
The passive activity rules, also called passive loss rules,
are designed to prevent individuals (as well as
, and certain corporations) from using losses from
passive investments to reduce other taxable income.
In general, the passive loss rules classify income, gain,
loss, and deductions as either portfolio items or trade
or business items. Portfolio income (such as interest,
dividends, royalties, annuities, and gain or loss from the
sale of portfolio assets) is excluded from the passive
activity rules. Trade or business activities are classified
annually as either passive or non-passive based on your
level of participation during the year. Rentals are treated
as trade or business activities that are generally passive
under the passive loss rules, regardless of your level of
participation. (Certain exceptions to this general passive
treatment of rentals are discussed above under Second
homes and rental property). Trade or business activities
may, in some cases, be grouped together if the activities
form an appropriate economic unit and satisfy other rules.
In this case, your level of participation is determined for
the grouped activity, rather than for each trade or business
activity within the group. In addition, it is important to note
that trade or business activities conducted by
you own are classified annually as
passive or non-passive based on the participation in the
activity by the individual, trust, or estate that is the partner
or S corporation shareholder.
Once passive trade or business activities are identified for
the tax year, the taxpayer aggregates all income, gain, loss,
and deductions from all passive activities. If the total is
passive income, then the passive loss rules do not restrict
use of any of the losses generated by passive activities.
If the total is a net passive loss, the net passive loss cannot
be used for any purpose in that tax year. The suspended
passive losses are reallocated among your passive
activities and are treated as though incurred in that activity
during the next tax year. The effect of the passive loss
rules is to suspend net losses from passive activities until
you have passive income or dispose of substantially all of
the activity in a fully taxable sale to an unrelated buyer.
Upon such a disposition, all suspended losses from that
activity become deductible against non-passive income.
If you intend to establish that one or more of
your trade or business activities is non-passive,
you should keep accurate and contemporaneous
records of the time you spend and of the nature
of your work in the trade or business.
Because the additional 3.8% net investment
income tax also applies to passive income,
consider the groupings that you are using for
purposes of the passive loss rules. The net
investment income tax rules allow taxpayers
who would be subject to this additional 3.8%
tax a one-time opportunity (in the first year that
the net investment income tax would apply) to
regroup their trade or business activities, using
the grouping rules that apply for regular income
tax purposes. The regrouping applies for both
regular and net investment income tax purposes.
Note that changes to the taxpayer’s groupings
must be disclosed.
Consider the impact of the passive loss rules
when making investments. Generally, making
investments that generate passive losses or
passive credits is unwise unless you have
sufficient passive income to offset the credits
or losses. Note that the passive loss rules may
recharacterize passive income from certain
activities as active, so you should confirm that an
income-generating investment would be properly
treated as passive.
Consider the timing of the disposition of passive
assets for purposes of both the passive loss
rules and the net investment income tax rules.
Sales of passive assets can allow use of certain
suspended losses, which can then reduce other
income or gain under the general income tax
rules (including, for example, the restrictions on
use of capital losses).
Excess Business Loss Limitation
For tax years beginning after December 31, 2017, non-corporate taxpayers,
such as individuals,
may be significantly impacted by a
new limitation imposed on the deductibility of trade or business losses. The
recently enacted federal tax legislation includes section 461(l) which introduces
a new “excess business loss” limitation. Under the new excess business loss
regime, the deduction for certain trade or business losses of a taxpayer may
be limited to $500,000 (for married individuals filing jointly) or $250,000 (for
other individuals, trusts, and estates). Such limitation amounts are indexed
The term excess business loss is defined as the excess (if any) of:
The aggregate deductions of the taxpayer for the taxable year which are
attributable to trades or business of such taxpayer (determined without
regard to whether or not such deductions are disallowed for such taxable
year under this provision), over
The sum of (a) the aggregate gross income or gain of such taxpayer for
the taxable year which is attributable to such trades or businesses, plus (b)
$250,000 (or 200% of such amount in the case of a joint return).
With respect to a taxpayer’s investment in a partnership or S corporation,
section 461(l)(4) provides that the taxpayer’s allocable share of income, gain or
deduction attributable to trades or businesses of a partnership or S corporation
are treated as trade or business income of the taxpayer for purposes of
calculating the excess business loss.
Section 461(l) is applied at the individual level after application of the passive
loss rules of section 469. Losses that are disallowed under section 461(l) may
be carried forward and are treated as part of the taxpayer’s net operating loss
(“NOL”) carryforward in subsequent tax years
As noted previously, the new tax law modified the net operating loss provisions
under section 172(a). The new law limits the deduction for any particular
year to 80% of taxable income for losses arising in tax years beginning after
December 31, 2017. Further, for losses incurred in tax years ending after
December 31, 2017, you are no longer permitted to carry back such losses, but
can carry forward such losses indefinitely. Due to the interaction of the excess
business loss and NOL provisions, you should carefully consider the timing (to
the extent possible) of realizing items that implicate section 461(l).