For most people, interest payments are a fact of life. Unless you're independently wealthy or have committed to leading an ascetic existence that requires no formal education, credit or significant assets, chances are good that you pay interest on a regular basis. From monthly mortgage payments to past-due credit card balances, these expenses can add up quickly.
You might be surprised to learn that some forms of interest are tax-deductible. While individual interest deductions rarely come with no strings attached, they can still provide substantial breathing room for folks in tight financial spots. First, we'll take a brief look at the world of tax deductions.
A Brief Review of Tax Deductions
While tax deductions come in all shapes and sizes, they all share some core characteristics. First, they must be claimed on state or federal income tax returns. Unlike tax credits, they don't provide dollar-for-dollar reductions to claimants' tax burdens. Instead, they allow filers to reduce their taxable income figures by specific amounts. In turn, this indirectly reduces their tax burdens.
Here's an illustrative example. If you paid $1,000 in mortgage interest last year, you can use the Mortgage Interest Tax Deduction to reduce your taxable income by the same amount. Depending on your tax bracket, this could knock anywhere from $100 to $400 off your total tax liability for the year.
Student Loan Interest Deductions
In many cases, the interest that you pay on your outstanding student loans can be deducted from your year-end tax burden. To qualify, you'll need to wait until you've begun to accrue interest on these loans. This generally occurs shortly after your graduation. Currently, the federal government caps student loan interest deductions at $2,500 per filer.
Mortgage Interest Tax Deduction
This is among the largest tax deductions that regular taxpayers can claim. If you're willing to itemize your deductions, you may be eligible to reduce your year-end tax burden by $2,000 or more. It's possible to deduct the mortgage interest on your primary residence and a second home. In most cases, the applicable mortgage must be a traditional vehicle that's secured by the outstanding equity in your home.
Investment Income Deductions
Under limited circumstances, you may be able to deduct the interest that you pay on qualifying investment loans. If you use margin loans to trade equities, a portion of the short-term interest that you pay may qualify for a tax write-off. Even better, you may also be able to offset related expenses like safe-deposit boxes and financial publications.
Business Credit Card Deductions
Although it's no longer possible to deduct the interest that you pay on your consumer credit cards, you may be able to write off a portion of the interest on your business credit cards. While you should avoid charging personal expenses to your business, it may be possible to write off "hybrid" activities like weekend retreats and restaurant meals as business expenses.
Past Credit Card Allowances
Until the mid-1980s, borrowers were permitted to deduct their consumer credit card interest. This loophole was closed with the 1986 enactment of the Tax Reform Act, but policymakers occasionally talk about bringing it back.
Final Thoughts: Deductions Reward Investment
It's often said that easy credit is good for the economy. While this is generally true, it's certainly possible for lenders to overextend themselves. Meanwhile, credit-happy consumers can cause plenty of problems for themselves and others.
At the same time, interest-related tax deductions are generally viewed as a net positive for the broader economy. By allowing them to keep some of the interest that they pay, these deductions boost consumers' spending power and benefit the businesses that they patronize. In other words, your interest tax deductions could have a wider impact than you ever thought possible.
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