Tax-deductible interest is a borrowing expense that the IRS allows taxpayers to claim on their federal or state tax returns, in order to reduce their taxable income. However, most tax-deductible interest must be claimed as an itemized deduction. This means that a tax benefit will only accrue if ALL itemized deductions exceed the standard deduction in the year for the filing status.
In 2022 the Standard Deduction is:
- Married filing jointly (MFJ): $25,900
- Single: $12,950
- Head of household (HoH): $19,400
Types of Tax-Deductible Interest
You can deduct interest that is associated with money you borrow to make investments, up to the amount of investment income you received in the tax year. You must have investment income to benefit from the deduction:
Investment Income includes:
- Taxable interest income
- Ordinary dividends
- Short-term Capital Gains
It does not include:
- Qualified Dividends
- Long-Term Capital Gains
An election can be made to include long-term capital gains and qualifying dividends in investment income in order to allow a larger amount of investment interest expense to be claimed. This requires that the long-term capital gain and qualifying dividends be taxed at ordinary income tax rates.
Investment interest expense includes, by definition, that which is associated with margin loans within a brokerage account. This is true even where a corresponding amount of equity is withdrawn from the account and used to pay taxes or buy a yacht. It is still subject to the investment income restriction and the itemized deduction requirement for Schedule A.
You may deduct interest that is charged to margin account during the tax year, regardless of when actually incurred. You can carry forward to the next or subsequent tax year any portion of your interest deduction that exceeds your net investment income in the present year.
Loan interest on a Securities-Based Loan (SBL) or line of credit (LOC) is NOT margin interest and is therefore tax deductible only where the funds are used for a business purpose – bear in mind that loan proceeds for a SBL / LOC cannot be used to buy more securities or pay down margin loans.
Home Mortgage Interest
You can claim the interest you are paying on the mortgage that is secured by your main home, defined by the IRS as where you live “most” of the time.
The allowable amount is ultimately based on the date of the mortgage, the amount, and how you use the mortgage proceeds.
- Your deduction is limited to interest associated with loans of $1 million (MFJ) or less to buy, build, or improve your home if you took out the loan prior to Dec. 16, 2017.
- It’s limited to loan amounts of $750,000 for the same nature taken out after Dec. 15, 2017.
These limits apply to all your mortgages in aggregate if you have more than one.
You can also claim tax-deductible interest on a mortgage that is secured by a second home, even if you do not spend any time there.
You can usually deduct mortgage points in the year paid, but only if you are the buyer in the transaction.
Interest associated with home equity loans may or may not be deductible. It depends on how you spend the money. It is deductible if you take out the loan to “buy, build, or substantially improve” the home or another dwelling. It is not deductible if you use the money for personal reasons. As with regular mortgage debt, it is subject to the overall aggregate limits.
Interest incurred on debt used to buy a rental property is deductible against the rental income from the property on Schedule E, not as an itemized deduction. There are no restrictions as to the size of loans taken out to buy rental properties.
Student Loan Interest
You can claim a tax deduction for interest paid up to $2,500 for the year, or the amount you paid, whichever is less.
You can claim the interest as an adjustment to income even if you claim the standard deduction or itemize.You won’t be able to claim the adjustment to income if you earn too much. The deduction begins to phase out at an AGI of $70K (Single) and $145K (MFJ). The deduction is completely disallowed once AGI exceeds $85K (Single) and $175K (MFJ).