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While personal interest, such as interest on personal loans or credit cards, is generally not deductible, there are some instances when it could be. Knowing which types of interest are deductible can help you save on your tax bill.

Student loan interest of up to $2,500 is deductible annually on loans used to pay for qualified higher education expenses. These expenses include tuition, fees, supplies, and room and board. Another perk of this deduction is that you can deduct the interest whether you itemize your deductions or claim the standard deduction.

However, there are some pitfalls to be aware of:

  • The deduction phases out for single taxpayers with income between $65,000 and $80,000 ($130,000-$160,000 if married filing jointly).
  • The deduction does not include amounts owed to a related party.
  • Taxpayers who can be claimed as a dependent on another taxpayer’s tax return are ineligible for the deduction.
  • In order to claim the deduction, you must be legally obligated to pay interest on a qualified student loan.
  • Parents and students should pay attention to these pitfalls when planning whose name the student loans will be in.

Mortgage interest is deductible from the purchase of a principal residence or a second home. The total amount of acquisition debt upon which mortgage interest is deductible is $1,000,000.

  • The interest is deductible when the debt is incurred in acquiring, constructing, or substantially improving any qualified residence and when the debt is secured by that residence.

In addition, interest on principal of up to $100,000 of home equity indebtedness is deductible.

  • If you are currently paying interest on credit cards or any other type of debt for which interest is not deductible, converting that debt to home equity debt could convert the non-deductible interest into deductible interest.
  • In order to deduct the interest on the home equity indebtedness, the total debt (home equity indebtedness + acquisition indebtedness) must not exceed the fair market value of the home.

Investment interest is deductible to the extent of investment income for the year. If interest expense exceeds investment income in a year, the excess interest expense can be carried forward to future years to offset future investment income.

Some pitfalls taxpayers should be aware of include the following:

  • This deduction is claimed on the taxpayer’s schedule of itemized deductions.
  • This means that taxpayers who have enough deductions to itemize are able to deduct the full amount of interest (to the extent of investment income).
  • For taxpayers whose income exceeds $261,500 ($313,800 if filing jointly) the deduction may be further limited by the phase out of itemized deductions for high income individuals.

If you have any questions regarding this or any other tax matters, please do not hesitate to contact your L&B professional at (858) 558-9200.

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