Investment Interest or Passive Interest?

[Paul C.]

If I take out a loan to fund an investment in a notes fund, is the interest paid on the loan "investment interest" that goes on Schedule A or "passive interest" that goes on Schedule E?

I found the following in "The CPA Journal":

IRC section 163(d)(3)(A) defines investment interest as interest that is paid or accrued on indebtedness properly allocable  to property held for investment. It does not include qualified residence  interest or interest incurred in connection with a passive activity. Property  held for investment is any property that produces portfolio income such as  interest, dividends, annuities, or royalties not derived in the ordinary course  of a trade or business. It also includes an interest held by a taxpayer in a  trade or business that is not a passive activity and in which the taxpayer does  not materially participate.

Based on the above, I think the interest would be classified as Investment Interest and go on Schedule A since the notes fund produces interest income.  However, the part that's confusing me is where it says, "Property held for investment is any property that produces portfolio income such as interest...NOT derived in the ordinary course of a trade or business."

Is the notes fund deriving interest in the ordinary course of a business?

Perhaps tax experts like @Amanda Han  or @Steven Hamilton II  could chime in.

Thanks in advance!

[Nathaniel Busch]

Paul, 

Your gut reaction is correct. Interest expense related to the acquisition of notes would be reported on Schedule A as investment interest expense. 

Now, if your main source of living and day to day trade consisted of actively acquiring notes at a discount, selling such notes at an amount in excess of your discounted purchase, etc. there seems to be an encroachment on the definition of an ordinary trade or business. Meaning, you would be approaching a Schedule C type situation in which gross receipts consist of interest income, etc. 

But, it seems as if this is purely investment related, so report the income on B, expense on A. 

Nathaniel Busch, CPA