We are often asked what types of interest are tax-deductible? Tax laws change frequently and people are often not aware of how these changes can affect their tax returns.
Student loan interest paid can be tax-deductible. There are income limits and eligibility rules that may keep someone from deducting the interest paid. Taxpayers may be able to deduct up to $2,500 of interest paid on qualified education loans for college or vocation school expenses. The deduction is available for interest on qualifying loans that were taken out for the benefit of the taxpayer, taxpayer’s spouse, or dependent at the time the debt was incurred.
For married filing joint taxpayers with taxable income under $140,000, student loan interest paid is fully deductible. For taxable income between $140,000 and $170,000, the deduction is limited. Taxable income over $170,000, the deduction is not allowed. For anyone who files single, head of household, or qualifying widow/widower, taxable income must be under $70,000 to receive the full deduction. For filers with taxable income between $70,000 and $85,000, the deduction is limited. When taxable income is over $85,000, the deduction is not allowed.
In December 2017, the Tax Cuts and Job Act (TCJA) made significant changes to the itemized mortgage interest deduction. The TCJA limited the deduction to the home mortgage interest on the first $750,000 of mortgage debt for mortgage loans taken out after December 15, 2017. Mortgages taken out before December 15, 2017, are limited to the first $1,000,000 of mortgage debt. This deduction is allowed for primary residences and second homes.
Home equity debt has also been limited. The TCJA rules state that home equity debt after October 13, 1987, can qualify for the mortgage deduction if it was used to renovate or improve an existing home. The loan must have been secured by the taxpayer’s home and not exceed the cost of the home. Home equity debt would not be deductible if used to pay personal expenses, pay off credit card debt or consolidate loans.
When refinancing a mortgage, any closing costs rolled into the loan will not be allowed toward the mortgage interest deduction. If you have taken out a mortgage, home equity loan or refinanced after December of 2017, keep your documents with your tax information so your preparer can have the information needed to calculate how much of your mortgage interest may be deductible.
People ask us about credit card interest being tax-deductible. The Tax Reform Act of 1986 eliminated personal credit card interest as a deductible expense. You can no longer deduct the interest incurred on everyday purchases on your taxes. This includes interest paid on personal loans, furniture, and medical expenses. You can deduct interest paid for business expenses. Personal expenses charged to a business credit card are still considered non-deductible.
Taxpayers must track the use of loan proceeds to determine the type of interest paid, known as interest tracing. Under interest tracing there is a 30-day rule which states loan proceeds can be allocated to expenses paid from any account if expenses are paid within 30 days before or after the loan proceeds are deposited in an account. It is not necessary that the actual loan proceeds were used to pay the expenses. If loan proceeds are used to acquire both personal and business use property the principal amount of the loan repayment are treated as repaid in the following order: personal expenditures, investment expenditures, rental real estate with active participation, former passive activities, and then trade or business expenditures. Best practice is to keep loan proceeds totally separate from other funds whenever possible. This can avoid reallocation by the IRS and may save important tax deductions.
If you itemize on your income tax return, you may be able to claim a deduction for your investment interest expenses. Investment interest expense is the interest paid on money borrowed to purchase taxable investments. This includes margin loans for buying stock in your investment account. This does not apply if you used the loan to buy tax-advantaged investments such as municipal bonds.
Do you know if you have been taking any of these deductions? Have you been paying student loan interest but not receiving the deduction? Do you think you may qualify to take one of these deductions? Ask your tax preparer to see if you qualify or ask for an explanation of why you do not qualify for a deduction. Understanding deductions on your income taxes can help you make better financial decisions when considering a new mortgage or how to fund your child’s education. Don’t have a tax preparer, come see us at Planning with Purpose. We would love to help!
