When it comes to debt, there aren’t many benefits, however, around tax time, certain types of debt may actually work to your advantage. That is, interest paid on outstanding debt may be tax deductible. Since tax laws vary based on income and other factors, always consult a tax advisor about your particular situation.
Home mortgage interest
Most people know that the interest they pay on their primary residence is tax deductible. What you may not know are the specific rules, which if not noted, could result in a very big surprise at tax time. Basically, an itemized deduction is allowed for interest paid on up to $1 million worth of mortgages used to purchase and/or upgrade your main residence, along with one additional home. Any other mortgages for additional dwellings are not tax deductible. Other stipulations may also apply based on your adjusted gross income for federal tax returns and may or may not be deductible on state or local returns, depending on your situation.
Home equity loan interest
In addition to the interest you pay on your main mortgage, you can also claim an itemized deduction for interest on a home equity loan up to a $100,000 loan amount. Home equity loans can be used for whatever you like, making them attractive for people looking to pay off car loans, credit cards bills and other consumer debt – all of which are not tax deductible. There are limitations to this deduction, however, with the requirement that your home equity claim not exceed the fair market value of your home. In addition, if you fall under the rules of the alternative minimum tax, this interest is deductible only if the money is used to buy, build or refurbish a first or second residence.
School loan interest
Along with home loans, interest paid on school loans for yourself, your spouse or your dependent may also be eligible for a tax deduction. An annual deduction of up to $2,500 is currently available for interest paid on qualified education loans, which includes money borrowed to pay for a college, university, post-secondary educational institution and certain vocational schools. Qualified educational deductions include a variety of expenses such as tuition, room and board, books and transportation. This deduction can be reduced depending on other specific circumstances – like tax free gifts received to pay for educational expenses, non-taxable employer provided educational assistance benefits and qualified tax-free scholarships, among other stipulations. In addition, as with mortgage interest, this tax deduction may be limited to taxpayers below a certain income threshold.
Investment interest
If you borrowed money to purchase taxable investment assets, you can deduct the investment interest expense of this income, including: interest, short-term capital gains and certain royalties. You can also treat all or part of your long-term capital gains and qualified dividends as investment income, allowing you to deduct more of your investment interest expense. But you’ll have to run the numbers because the amount of long-term gains and dividends that you treat as investment income will be taxed at your regular rate instead of the normal 15 percent or less for such gains.
Learn the tax laws
If you pay interest on your debt and think it may be tax deductible, it’s smart to learn the tax law basics or to consult an accountant. A professional accountant can help ensure you file correctly and that you claim all available deductions.
Related Articles