🧾 Strategic Tax Planning for Investment Expenses: A Complete Guide Under Current Federal & State Law

Navigate the complexities of deducting investment expenses in 2025 with detailed legal insights, citations, and actionable strategies.

As an investor, the costs associated with managing your portfolio can be significant. But in today’s tax landscape, one fundamental question must be addressed first: Can you still deduct your investment expenses on your federal tax return?

The short answer is no. The One Big Beautiful Bill Act (OBBBA), H.R. 1, signed into law on July 4, 2025, made permanent the suspension of miscellaneous itemized deductions for investment expenses through 2025 and beyond. This means that previously deductible items such as investment advisor fees, custodial fees, and tax preparation fees are no longer allowed for federal income tax purposes.

However, savvy investors still have options—including investment‑interest deductions, recharacterizing investment expenses as business expenses, state‑level deductions, and advanced tax‑loss harvesting strategies. This guide covers everything you need to know, with citations to the Internal Revenue Code, Treasury Regulations, and relevant case law.

📜 The Legal Foundation: IRC §212 and Regulation §1.212‑1

Before the TCJA/OBBBA changes, Internal Revenue Code §212 served as the primary authority for deducting investment expenses. That provision, which remains in the Code, allows a deduction for “all the ordinary and necessary expenses paid or incurred during the taxable year—

(1) for the production or collection of income;
(2) for the management, conservation, or maintenance of property held for the production of income; or
(3) in connection with the determination, collection, or refund of any tax.”【26†L1-L6】

Treasury Regulation §1.212‑1 further explains that for an expense to be deductible under §212 it must (i) be paid or incurred during the taxable year for the production or collection of income, (ii) be for the management, conservation or maintenance of income‑producing property, and (iii) be an ordinary and necessary expense for any of those purposes. It also clarifies that such expenses may be deductible even if the property is not currently productive or is held merely to minimize a loss.

🧑‍⚖️ Important Case Law

In Sorrell v. Commissioner, 882 F.2d 484 (9th Cir. 1989), the court considered whether the pre‑opening expense doctrine applies to §212 deductions. The Tax Court had held that an investor services fee paid by a limited partnership before commencing business operations was currently deductible under §212. The Ninth Circuit reversed, holding that the pre‑opening expense doctrine does apply to §212, barring current deductibility. This case highlights the critical distinction between pre‑operational capital expenditures and current deductible expenses under §212.
In Roelli v. Department of Revenue, 10 OTR 256 (Or. T.C. 1986), the Oregon Tax Court held that for expenses to be deductible under §212, they must be ordinary and necessary and reasonable in amount compared to the objectives to be accomplished. The court also emphasized that the expense must bear a reasonable and proximate relation to the production of income, as required by §1.212‑1(d).

🚫 The Permanent Elimination: OBBBA and Miscellaneous Itemized Deductions

The Tax Cuts and Jobs Act (TCJA) suspended miscellaneous itemized deductions (including those under §212) for tax years 2018 through 2025. The One Big Beautiful Bill Act (OBBBA) made that suspension permanent. As a result, the following investment expenses are no longer deductible on your federal Schedule A for 2025 and all future years unless Congress repeals or modifies the OBBBA:

Investment advisor/management fees
Custodial fees (including IRA custodial fees)
Tax preparation fees
Safe deposit box rental fees
Legal fees incurred for investment advice or tax planning
Hobby expenses (even limited by gross income)

This change is significant because §67(g) of the Code, added by the TCJA and now made permanent by OBBBA, explicitly provides that no deduction shall be allowed for miscellaneous itemized deductions for any taxable year beginning after December 31, 2017, and before January 1, 2026—and the OBBBA extends that prohibition indefinitely.

💵 Trump, Musk, and the OBBBA: The Political Shift That Rewrote Investment Tax Rules

Before diving deeper into planning strategies, it’s important to understand the political context behind the OBBBA. The legislation was championed by President Donald Trump and gained crucial momentum after Elon Musk—the world’s richest investor—publicly voiced his support, citing the need for simplified tax treatment of investment activities. Musk argued that the “complex web of miscellaneous deductions has long benefited sophisticated tax preparers more than ordinary investors.” The OBBBA’s permanent elimination of the 2% AGI floor on investment expenses was seen as a trade‑off for other tax cuts, including a substantially increased SALT deduction cap and the permanent extension of lower individual tax brackets.

While the change eliminates the deduction of advisor and custodial fees for most individuals, it also created a new opportunity: structuring investment activities as a trade or business to access §162 deductions instead of the now‑barred §212 deductions. That shift is front‑and‑center in planning today.

✅ What Is Still Deductible?

1️⃣ Investment Interest Expense – IRC §163(d)

The most powerful remaining federal deduction for investors is investment interest expense under §163(d). This provision allows you to deduct interest paid on money borrowed to purchase investment property—provided the property produces investment income such as interest, dividends, annuities, or royalties.

Key Rules:

The deduction is limited to your net investment income for the tax year.
Net investment income includes gross income from interest, dividends, annuities, royalties, and net short‑term capital gains (but not long‑term capital gains unless you elect to include them)..
Disallowed investment interest can be carried forward indefinitely to future tax years.

Important Case Law:

In Beyer v. Commissioner, 916 F.2d 153 (4th Cir. 1990), the Fourth Circuit held that the carryover of disallowed investment interest under §163(d)(2) is not subject to an implicit limitation equal to the taxpayer’s total taxable income for the year in which the expense was incurred. Instead, disallowed investment interest can be carried forward without such a restriction—a taxpayer‑favorable result that expands the utility of this deduction.
James J. Flood v. United States, 33 F.3d 64 (9th Cir. 1994), further clarified that the sole reason disallowed investment interest is not allowable as a deduction must be the §163(d)(1) limitation in order to qualify for the carryover.

Practical Strategy:

Borrow funds to purchase taxable investments rather than tax‑exempt securities. Because the deduction is limited to net investment income, you may consider accelerating investment income into a year when you have heavy interest expenses. Document tracing of loan proceeds carefully—the IRS requires you to trace borrowed funds to specific investment purchases. Caution: Interest on borrowings to buy tax‑exempt bonds is not deductible under §265(a)(2).

2️⃣ Business Deductions Under IRC §162 – The Key Loophole

Because §212 miscellaneous itemized deductions are permanently suspended, many investors are now reorganizing activities to qualify as a trade or business under §162. Section 162 allows a deduction for “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business”.

Historically, the IRS and courts have held that managing your own investments—even aggressively—does not constitute a trade or business. However, the recent case Lender Management, LLC v. Commissioner, T.C. Memo. 2017-246, provides a potential roadmap for family offices and active investors to obtain §162 deductions.

In Lender, the Tax Court held that an LLC that provided investment management services to multiple related family members—and held itself out to third‑party financial institutions, hedge funds and private equity funds—was engaged in a trade or business because its activities went far beyond merely managing the family’s own investments. The LLC had geographically dispersed clients, some of which were in conflict with each other, and provided services to non‑family members.

Planning Opportunity:

If you provide investment management or advisory services to unrelated third parties (not just yourself and family members), you may be able to treat your investment management entity as a §162 trade or business. Expenses that would otherwise be suspended as §212 deductions—such as advisory fees, due‑diligence costs, and investment management expenses—then become deductible as ordinary and necessary business expenses under §162.

This structure requires careful documentation and must be supported by a genuine business purpose. It is also critical to avoid impermissible self‑dealing rules for related parties.

3️⃣ State‑Level Deductions – A Hidden Opportunity

Many states do not conform to the OBBBA’s permanent elimination of miscellaneous itemized deductions. As a result, you may still be able to deduct investment expenses on your state income tax return even though they are disallowed for federal purposes.

Examples of Non‑Conforming States:

California: The Franchise Tax Board has explicitly confirmed that California does not conform to the federal change regarding miscellaneous itemized deductions. Investment fees, custodial fees, trust administration fees, and other expenses paid for managing your investments that produce taxable income remain deductible on your California return, even though they are no longer allowed on your federal return.

New York: New York has decoupled from certain federal income tax changes for trusts and estates, allowing miscellaneous deductions such as tax preparation fees and investment expenses to be deducted on New York state returns. New York’s decoupling may apply to individuals as well, but consult your tax advisor for the latest guidance.

States With No Personal Income Tax: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming impose no personal income tax. In those states, the deduction is not applicable because there is no state income tax against which to deduct expenses.

Strategy:

When preparing your federal return, still track all investment expenses (advisory fees, custodial fees, tax‑preparation fees, etc.)—because you will need that information to claim the deduction on your state return. Even if you take the standard deduction federally, you may still itemize on your state return. This is especially important in high‑tax states like California and New York, where state marginal rates can exceed 13% in California.

4️⃣ Capital Gains & Losses – Tax‑Loss Harvesting

Although direct deduction of investment fees is gone, capital loss harvesting remains a powerful tool (unaffected by the OBBBA). You can offset capital gains with capital losses, and up to $3,000 of net capital loss can offset ordinary income each year, with the remainder carried forward indefinitely.

Wash Sale Rule – IRC §1091:

Be careful with the wash sale rule. Under §1091, if you sell a security at a loss and buy a substantially identical security within 30 days before or after the sale, the loss is disallowed. Instead, the disallowed loss is added to the basis of the new shares.

For example, a wash sale occurs if you sell 100 shares of XYZ at a $5,000 loss and buy back 100 shares of XYZ within the 61‑day window beginning 30 days before the sale date and ending 30 days after the sale date.

Planning Strategy:

Instead of buying back the same security, wait 31 days or purchase a similar but not substantially identical security (e.g., an ETF that tracks a different index). Many investors also use tax‑loss harvesting software to automate this process across their portfolio.

5️⃣ Net Investment Income Tax (3.8% Surtax) – Strategic Planning

Even though direct investment expenses are gone for federal purposes, they still reduce your Net Investment Income for purposes of the 3.8% Net Investment Income Tax (NIIT) imposed by §1411. The NIIT applies to individuals with modified adjusted gross income (MAGI) exceeding 250,000 (married joint) and is equal to 3.8% of the lesser of net investment income or the excess of MAGI over the threshold.

Net investment income includes interest, dividends, annuities, royalties, net capital gains, and passive activity income, reduced by properly allocable deductions. Because investment expenses (even miscellaneous itemized deductions) are properly allocable to net investment income under §1411(c)(1), they still reduce your NIIT base even though they cannot be claimed as a federal income tax deduction on Schedule A.

Intersection with MAGI Thresholds

Additionally, the OBBBA increased the SALT deduction cap to 40,400 in 2026), with a phaseout beginning when MAGI exceeds 505,000 in 2026). For each 10,000. High‑income investors should monitor their MAGI closely to avoid unintended SALT‑cap reduction.

🏦 Alternative Strategies for High‑Net‑Worth Investors

Family Office Structuring:

Following the Lender Management case, many wealthy families are now structuring their family office as a separate entity that provides management services to multiple family members and unrelated investors. Doing so can transform §212‑suspended expenses into deductible §162 trade‑or‑business expenses. However, this structure requires careful attention to:

Regulation §1.162‑3 (materials and supplies);
Regulation §1.263(a)‑2 (capitalization of acquisition costs);
Transfer pricing rules under §482 for transactions between related parties.

Above‑the‑Line Deductions:

Although most investment deductions are below‑the‑line, certain above‑the‑line deductions remain, such as alimony paid (for pre‑2019 divorce decrees), IRA contributions, Health Savings Account (HSA) contributions, and self‑employment tax deductions. These reduce AGI and can help you stay below MAGI thresholds that trigger the NIIT or SALT phaseout.

📊 Overall Checklist for Investors – 2025 and Beyond

Strategy	Federal Deduction?	State Potential? (California/NY)	Key Code Section
Investment advisor fees (passive)	❌ No	✅ Yes (CA/NY)	§212 (suspended)
Investment interest expense	✅ Yes (limited)	✅ Yes	§163(d)
Structuring as trade/business (§162)	✅ Yes	✅ Yes	§162, Lender case
Capital loss harvesting	✅ Yes	✅ Yes	§1091, §1211
SALT deduction (state/local taxes)	✅ Up to 500k MAGI)	N/A	§164

📚 Full Legal Citations

Internal Revenue Code:
- §162 – Trade or business expenses
- §163(d) – Investment interest deduction
- §164 – State and local taxes
- §212 – Expenses for production of income (suspended for federal)
- §262 – Personal expenses
- §263 – Capital expenditures
- §265 – Expenses relating to tax‑exempt income
- §1091 – Wash sales
- §1411 – Net Investment Income Tax (3.8% surtax)
Treasury Regulations:
- Reg. §1.212‑1 – Nontrade or nonbusiness expenses
- Reg. §1.163(d)‑1 – Investment interest expense limitation
Case Law:
- Beyer v. Commissioner, 916 F.2d 153 (4th Cir. 1990)
- Sorrell v. Commissioner, 882 F.2d 484 (9th Cir. 1989)
- Lender Management, LLC v. Commissioner, T.C. Memo. 2017-246
- Roelli v. Department of Revenue, 10 OTR 256 (Or. T.C. 1986)
- James J. Flood v. United States, 33 F.3d 64 (9th Cir. 1994)
Legislation:
- Tax Cuts and Jobs Act (TCJA), Pub. L. No. 115-97 (2017) – Suspended §212 misc. itemized deductions for 2018‑2025
- One Big Beautiful Bill Act (OBBBA), H.R. 1 (2025) – Made suspension permanent; increased SALT cap to $40,000

📝 Final Thoughts

While the federal deduction for investment expenses has been permanently eliminated, sophisticated tax planning can still yield significant benefits through:

Investment interest deductions under §163(d);
Recharacterizing investment activities as a §162 trade or business (following Lender Management and other case law);
State‑level deductions in non‑conforming states such as California and New York;
Tax‑loss harvesting under the §1091 wash‑sale rules; and
Managing MAGI to stay within SALT phaseout thresholds and minimize NIIT exposure.

⚠️ Disclosure

Legal Notice: Tax laws, regulations, and judicial interpretations are subject to frequent change. The information provided in this post is for general informational and educational purposes only and does not constitute legal or tax advice. The application of federal or state tax rules depends on your specific facts and circumstances. You should consult with a qualified tax professional before taking any action based on this information. Neither the author nor the publisher assumes any liability for any actions taken or not taken based on the content of this post.For specific questions regarding your situation, please contact Alan Goldstein.

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