Paying interest is a reality that most of us deal with, whether we like it or not. Be it your student loans or home mortgage, there are a number of common debts that accrue interest. The longer interest accrues, the more expensive repayment becomes—and when you’re dealing with tens or hundreds of thousands of dollars of debt, interest can quickly add up. Even if you’re fortunate enough to have low interest rates, it’s only natural to seek ways to reduce your overall outgoing costs. Believe it or not, tax season may be the ultimate break to catch when it comes to paying interest. Now comes the golden question: is interest on debt tax-deductible? The answer is sometimes—using this guide, we’ll walk you through the types of interest that are tax-deductible, the benefits of deducting interest, and provide answers to relevant commonly asked questions.
- What Types of Interest are Eligible for Deduction?
- What is the Benefit of Deducting Paid Interest?
- Tax-Deductible Interest FAQs
What Types of Interest are Eligible for Deduction?Before the imposition of the Tax Reform Act of 1986, taxpayers were allowed to deduct interest on a sprawling array of debts, including credit card debt and personal loans. This mid-1980s tax reform law effectively ousted deductions for personal interest, thereby making credit card, personal loan, and medical loan interest exempt from deduction on tax returns. Though the tax laws regarding interest haven’t changed much over the course of the past few decades, there are a number of tax-deductible interest types that are designed to reduce your annual taxable income. Interest paid on student loans, mortgages, business loans, and margin debts are among the most common. Let’s take a more in-depth look at how each of these types of interest can affect your tax filing and what forms you’ll need to deduct them.
Student Loan InterestAs of 2020, there are an estimated 44.7 million borrowers with student loan debt—most of which will likely be able to deduct accrued interest on their tax returns. This number continues to amass with every passing year, and to accommodate the ever-increasing number of university students burdened with weighty debts, the IRS grants a student loan interest deduction. The student loan interest deduction allows you to deduct a maximum of $2,500 from your taxable income so long as your modified gross income (MAGI) was less than $70,000 in the past tax year. The loan(s) in question must qualify under IRS standards to be eligible for tax-deductibility. Qualified loans must be taken out by either you, the taxpayer, a spouse, or a dependent. Qualified loans also must have been taken out for educational purposes during a time in which you, your spouse, or dependent is enrolled at least part-time in a degree program. Additionally, the loan in question must have been used to pay for tuition, textbooks, coursework supplies, fees, or other relevant expenses. Qualification for the student loan interest deduction is also contingent upon the educational institution’s eligibility. Under IRS mandate, eligible institutions include all public, non-profit, and privately-owned-for-profit post-secondary institutions that participate in student aid policies managed by the US Department of Education. If you paid more than $600 in interest in 2019, you will automatically receive Form 1098-E in the mail or via email. If you paid less than $600, you can still deduct paid interest—you will need to contact your student loan provider and request a physical or digital copy of Form 1098-E.
Business Loan InterestGrowing and operating a business requires a number of expenses that are often funded by business loans. From accommodating lines of credit to property mortgages, there are a number of uses for everyday business loans. Like any other loan, business loans accrue interest over time. Fortunately, this interest is tax-deductible under certain conditions. These conditions include a true lender-debtor relationship, legal liability for the debt, and an agreement from both lender and debtor for the debt to be repaid. The type of loan you have will also impact how much of your interest is tax-deductible. The following are among the most common types of business loans that may be eligible for small business deductions:
- Term Loans
- Business Lines of Credit
- Short-Term Loans
- Personal Loans (for mixed purposes)
- Business Purchase Loans