Can I deduct mortgage interest over $750,000 as investment income when using loan for stocks?

This is a nuanced tax question that hinges on tracing rules and allocation of debt proceeds. You're on the right track with Publications 936 and 550. The key issue here is whether you can allocate part of your mortgage interest as investment interest. The answer is yes, but with some important caveats: First, you need to demonstrate clear tracing of the mortgage proceeds to investment use. This means the money should go directly from the mortgage to your investment account, or you need meticulous documentation showing the flow of funds. Second, while you're correct that interest on amounts over the $750,000 limit can potentially be deducted as investment interest expense, this deduction is limited to your net investment income for the year. If your investments don't generate sufficient income, the excess investment interest expense gets carried forward. Third, the "choice to treat debt as not secured by your home" provision is valid, but it applies to the entire loan, not just the portion over $750,000. Making this election could give you more flexibility but also means giving up the home mortgage interest deduction entirely. Your CPA is being cautious because this strategy, while legal, does require careful documentation and might invite additional scrutiny. If you pursue this, maintain impeccable records tracing the loan proceeds directly to your investment activities. Remember that investment interest deductions only apply against investment income, not against ordinary income. So the potential benefit depends on your overall investment income picture.

After struggling with a somewhat similar situation last year, I found an incredibly helpful tool at https://taxr.ai that analyzes mortgage interest allocation rules. I was buying a $1.2M property and planning to use about $300K of the mortgage proceeds for my rental property business. The standard mortgage broker and my regular accountant were both giving me conflicting advice about how to properly allocate the interest deductions. I uploaded the relevant IRS publications and my specific scenario to the tax analyzer tool, and it produced a detailed analysis showing exactly how to trace the proceeds and document the allocation between personal residence interest and business interest. What was most helpful was that it actually created a compliant documentation template showing exactly what records I needed to maintain for proper allocation. It explained the requirements from both Publication 936 and 550 specific to my situation, rather than just general advice. The tool also identified a specific Revenue Ruling that addressed my situation that neither my broker nor accountant had mentioned. It saved me a ton of research time and gave me confidence in taking the deductions properly.

Just wanted to follow up - I tried that taxr.ai tool mentioned above and it was exactly what I needed. I was dealing with almost the identical situation (mortgage over the limit, wanting to use proceeds for investments) and was getting nowhere with my research. The documentation templates were super detailed and it laid out exactly how to create the paper trail from mortgage closing to investment account. It even identified a couple of pitfalls I wouldn't have considered, like timing issues between when you receive proceeds and when you make investments. What surprised me was the specific guidance on how to make the election to treat part of the debt as not secured by my home - apparently this requires a specific statement attached to your tax return. My CPA had no idea about this requirement! It also explained the limitations on investment interest deductions really clearly and helped me run some scenarios to see if this strategy actually made sense in my specific situation with my investment income. Definitely worth checking out if you're trying to navigate this particular tax situation.

My experience dealing with the IRS on a similar issue was a nightmare. I bought a home for $1.3M in 2023, took out a $1M mortgage, and used $300K for starting my business. My tax preparer filed following the rules for allocating mortgage interest, but the IRS sent a notice questioning my deductions. I spent MONTHS trying to get someone on the phone at the IRS to explain my documentation. Always busy signals or disconnections after hours on hold. I finally found https://claimyr.com through a real estate investor group and their service got me connected to an actual IRS agent in about 20 minutes. You can see how it works at https://youtu.be/_kiP6q8DX5c if you're curious. The IRS agent confirmed my approach was correct but said I was missing a specific form that needed to be attached to my return. The whole issue was resolved in one phone call after months of frustration. If you're going to pursue this mortgage interest strategy, just know that if you do get questions from the IRS, getting through to them to resolve it is its own challenge.

Had to come back and admit I was wrong about Claimyr. After expressing skepticism in my earlier comment, I decided to try it anyway because I was desperate to resolve my IRS issue about investment interest deductions. The service actually worked exactly as described. I signed up, and about 35 minutes later got a call connecting me to an IRS representative. After 6+ months of trying to get through on my own (and failing), I finally got my investment interest deduction questions answered. The agent confirmed that yes, you can allocate mortgage proceeds to investment use and deduct the interest as investment interest expense, but they emphasized the importance of documentation. They told me exactly what records I needed to maintain and what form to include with my return. For anyone dealing with this mortgage interest allocation issue, getting clear guidance directly from the IRS was invaluable. I'm normally very skeptical of services that seem too good to be true, but in this case, I'm glad I gave it a shot. The peace of mind from having my specific situation addressed by the IRS directly was worth every penny.

Something nobody has mentioned yet - even if you CAN do this technically, you should really run the numbers to see if it's worth it. Investment interest can only offset investment income (generally interest, non-qualified dividends, and short-term capital gains). If your stocks are primarily growth-focused or pay qualified dividends, you might not have enough investment income to take advantage of the deduction anyway. I went through this whole process last year with a $1.2M mortgage, kept meticulous records, and then barely had any eligible investment income to deduct against. Also, with interest rates where they are now, you'd need a pretty good return on those investments to come out ahead after taxes. Just make sure you're not jumping through all these hoops for a negligible benefit.

Has anyone here actually been audited while taking this position? I've been thinking about this exact scenario but I'm terrified of an audit. My tax person says this is a "gray area" even with good documentation.

Your interpretation of the IRS publications is correct, but there are several practical considerations your CPA is likely concerned about that are worth discussing. You're right that Publication 936 specifically addresses this scenario - when mortgage proceeds exceed the $750k limit but are used for investment purposes, the excess interest can potentially be deducted as investment interest expense. The key phrase is "potentially" because of the limitations involved. First, the tracing requirement is strict. You'll need to demonstrate that the funds went directly from mortgage proceeds to investments. This typically means same-day or next-day transfers with clear documentation. I'd recommend opening a separate investment account funded solely by the mortgage proceeds to create an unambiguous paper trail. Second, investment interest deductions are limited to your net investment income for the year. This includes interest, non-qualified dividends, and short-term capital gains - but NOT long-term capital gains or qualified dividends unless you make a specific election to treat them as ordinary income (giving up the preferential tax rates). Third, your CPA's caution about Publication 550 is valid - it specifically excludes qualified home mortgage interest from investment interest treatment. However, the portion over $750k that you're allocating to investments wouldn't qualify as "qualified home mortgage interest" anyway. The election to treat debt as not secured by your home is another option, but it's an all-or-nothing choice for the entire loan, not just the excess portion. Given current interest rates and the limitations on investment income, run the numbers carefully to ensure the strategy makes economic sense beyond just the tax benefits.