Tax Exempt Income and Schedule A deductions

[DMICPA]

Taxpayer has $900,000 of tax exempt interest, $100,000 of taxable interest.
Taxpayer has property taxes of $80,000 and other itemized deductions of $20,000.

With the exception of AMT, the taxpayer owes no income taxes.

Could the IRS assert that some portion of the itemized deductions could possibly be paid using tax exempt interest and thereby disallow some of the Schedule A deductions?

I know that the investment advisor fees are allocated between taxable and tax exempt but I have never heard of any other deductions being allocated as such.

Am I correct in taking the entire itemized deductions as there is no logical reasoning to allocate other deductions.

Need some wisdom here.

[Bees Knees]

There is a rule that the fiduciary expenses of an estate and a trust must be allocated between tax exempt and taxable interest income. Likewise, as you stated, investment expenses must be allocated between tax exempt and taxable interest.

Other itemized deductions for an individual, such as mortgage interest, real estate taxes, and charitable contributions do not need to be allocated between tax exempt and taxable interest. It does not matter what the source of the income is. Those expenses are fully deductible even if they are paid using tax exempt funds.

[DMICPA]

Wow: this is a deal. The client could have a million bucks of tax exempt income and have three homes, a fleet of cars etc. and pay no Federal Income tax and no state tax if the source of the tax exempt income is in the same state as the taxpayer.