4 Kinds of Deductible Interest Expenses

Barry Lisak writes: Interest is an amount you pay for the use of borrowed money. To deduct interest you paid on a debt on your tax return, you must be legally liable for the debt and you must be able to itemize your tax deductions on your tax return. Interest tax deductions fall into four major categories:

1. Home-mortgage interest. Home-mortgage interest is interest you pay on a loan secured by your main home or a second home.

Your main home is where you live most of the time. It can be a house, cooperative apartment, condominium, mobile home, house trailer, or houseboat that has sleeping, cooking, and toilet facilities. The loan may be a mortgage to buy your home, a second mortgage, a home-equity loan, or a line of credit. Mortgage interest is reported to you on Form 1098, Mortgage Interest Statement by the lender to which you made the payments.

2. Points. In addition to the interest rate on a mortgage, lenders usually charge points. The points are paid up front at closing. Whether the charge is called a loan-origination fee or discount fee, points are deductible on your tax return if they are charged for the use of money. Points paid for a second home must be deducted over the life of the loan. Points paid solely to refinance your home mortgage cannot be deducted on your tax return in the tax year paid. Instead, they must be deducted on your tax return over the life of the loan. In other words, if you have a 30-year loan, and the points are $3,000 you can deduct $100 per year as interest expense on Form 1040, Schedule A. If you pay off the loan early, you may deduct all outstanding points (interest) in that year.

3. Investment interest. Investment interest, which is any interest incurred to buy or carry investment property, is tax-deductible on your tax return up to the amount of your net investment income. Margin-loan interest paid to purchase taxable stocks and bonds falls into this category. Any investment interest that is disallowed may be claimed forward to future years. When the investment is sold, any interest expense not previously deducted may be added to the cost basis of the asset. This will save you possible capital-gain taxes. You calculate your investment interest deduction of Form 4952, Investment Interest Expense Deduction.

4. Student-loan interest. This interest is partially tax-deductible on Form 1040, not on Schedule A. The maximum deduction is $2,500 and is based on filing status and income limits. You do not have to itemize your deductions to deduct student loan interest. A qualified student loan is one that you took out solely to pay qualified education expenses for you, your spouse, or a dependent.

If you paid $600 or more of interest on a qualified student loan during the year, you will receive a Form 1098-E, Student Loan Interest Statement, from the entity to which you paid the student loan interest.

Caution: Personal interest, which includes interest paid on car loans, credit cards, and personal loans, is not tax-deductible at all on your tax return.