(b) No deduction shall be allowed for any of the following:

1. (1) Any amount otherwise allowable as a deduction which is allocable to one or more classes of income other than interest (whether or not any amount of income of that class or classes is received or accrued) wholly exempt from the taxes imposed by this part, or any amount otherwise allowable under Section 212 of the Internal Revenue Code (relating to expenses for production of income) which is allocable to interest (whether or not any amount of such interest is received or accrued) wholly exempt from the taxes imposed by this part.
2. (2) Interest on indebtedness incurred or continued to purchase or carry obligations the interest on which is wholly exempt from the taxes imposed by this part. The proper apportionment and allocation of the deduction with respect to taxable and nontaxable income shall be determined under rules and regulations prescribed by the Franchise Tax Board.
3. (3) Interest on indebtedness incurred or continued to purchase or carry shares of stock of a management company or series thereof which during the taxable year of the holder thereof distributes exempt-interest dividends.

(c) For purposes of paragraph (2) of subdivision (b):

1. (1) “Interest” includes any amount paid or incurred—

   1. (A) By any person making a short sale in connection with personal property used in that short sale, or
   2. (B) By any other person for the use of any collateral with respect to that short sale.

2. (2) If—

   1. (A) The taxpayer provides cash as collateral for any short sale, and

   2. (B) The taxpayer receives no material earnings on that cash during the period of the sale,

      subparagraph (A) of paragraph (1) shall not apply to that short sale.

(d) No deduction shall be denied under this section for interest on a mortgage on, or real property taxes on, the home of the taxpayer by reason of the receipt of an amount as either of the following:

1. (1) A military housing allowance.
2. (2) A parsonage allowance excludable from gross income under Section 107 of the Internal Revenue Code.