A tax deduction from your federal tax return does not mean that you can deduct your federal income tax from your gross income. A tax deduction means that you can deduct taxes other than federal income tax from your gross income.
Concerning allowable tax deductions, many individuals want to know precisely when they can and can’t deduct interest expenses.
Although you can deduct interest in many circumstances, there are times when interest expenses do not fall within the allowable tax deductions. Nevertheless, interest expense deductions can be a significant way of reducing your income tax amount when permissible.
So, what are allowable interest deductions available to the individual taxpayer under federal income tax law?
The general rule is this: Non-personal interest paid or accrued in the tax year may be deductible.
- Student Loan Interest may be deductible on qualified student loans if you paid the interest in the tax year and are not “married filing separately.” If filing jointly, your modified AGI must be less than $70,000 and under $145,000.
- Home mortgage interest can be deductible if it is interest on a loan used to develop, build or substantially improve a home that serves as a principal residence. There are limits and constraints on deducting home mortgage interest.
- Investment interest is generally deductible but is limited to the taxpayer’s net investment income for the year. The good news on the limitation is that you can carry the deduction forward if you overextend your limit for the tax year.
Under the federal income tax law, particular types of interest are not deductible. Typically, personal interest is not deductible. What constitutes “personal interest”?
- Interest in personal credit cards
- Car loan interest, if the vehicle was not for business use
- Interest on loans used for personal purposes if a personal residence did not secure the loan.
Remember that interest may occasionally be deducted as a business expense if it occurs in connection with a trade or business. But there are different and often complicated regulations that govern the federal income tax law relating to business expense deductions.
What Types of Tax Are Deductible?
Any tax that is NOT federal income tax (excise, transfer, luxury tax, etc.) is deductible from your gross income. State, local, and foreign income taxes are all deductible. One significant tax that is not deductible from a person’s gross income is a sales tax.
Businesses may deduct sales tax from their gross income, though. State income taxes are deductible in the year following taxation since a taxpayer cannot know his accurate taxation amount until the year after he pays his taxes.
What Is an Interest Deduction?
The IRS permits an interest deduction because the taxpayer was forced to pay interest on an incurred debt. The general practice is that interest is deductible. The main exception to this is that consumer interest is not deductible. The exception almost eradicates the main rule because things like credit card interest payments and other similar interest payments are not deductible from gross income.
Is Qualified Residence Interest Deductible?
The IRS has decided that this particular type of consumer interest is deductible. Interest charged on loans secured by a qualified residence is deductible. The taxpayer may deduct interest on a loan repayment on two homes. The maximum a taxpayer may borrow towards those homes is $1,000,000 for an acquisition indebtedness home (standard mortgage home) or $100,000 for an equity indebtedness home (standard home equity loan).
Are Any Other Types of Interest Deductible?
To give recent former students a break during the early years of their education loan repayment process, the IRS has selected to authorize those paying interest on education loans to deduct up to a maximum of $2500 per year from their gross income.
Mortgage Interest and Mortgage Insurance
After you buy a home, you can deduct all of your interest payments on any mortgage up to $750 million (per changes to the tax code beginning Dec. 14, 2017).
There are regulations on this popular homeowner tax deduction, however. First, you can only deduct the interest on a mortgage up to $750 million if you are married and filing jointly. If you are married and filing separately, you and your spouse can only claim interest up to $375,000.
Subsequently, a first or second home must secure the mortgage debt.
If your bank instructs you to buy private mortgage insurance, those premiums are tax-deductible in some circumstances. However, the deduction amount is scaled back once your income reaches $100,000 a year.
Points
It is common to see fees in the amount of one to three points on a home loan. (One point is equal to 1% of the mortgage loan principal.) These fees are included on the income tax deductions list and can be deducted if associated with purchasing a home.
If you are refinancing your home mortgage, points are still fully deductible but must be done over the life of the loan and not upfront. If you refinance your home, you can write off the remainder of old mortgage points.
Equity Loan Interest
Some individuals may be able to deduct some of the interest paid on a home equity loan (line of credit) from their 1040s. However, the Internal Revenue Service restricts the amount of debt that can be treated as home equity for this tax deduction. You are limited to deducting the smaller of:
- $100,000 if filing jointly, or $50,000 for each individual of a married couple if filing separately, or
- Your home’s total fair market value minus certain outstanding debts against the home
Interest in a Home Improvement Loan
The fourth item on the homeowner tax deductions list is the interest on a home improvement loan of up to $750,000 (per changes in the tax code in 2018).
Many individuals find it critical to take out a loan to make repairs or improve their homes. However, it’s necessary to distinguish these two types of work because only the interest on loans taken out for home improvements can be deducted from your income taxes.
A qualifying loan is taken out to add “capital improvements” to your home. The improvement must improve your home’s value, acclimate it to new uses, or extend its life. Samples of capital improvements include adding a third bedroom, a garage, installing insulation, or landscaping.
Loans that do not qualify for interest deduction are taken out for repairs only. Samples of repairs include painting, plastering, fixing broken windows, or replacing cracked tiles.
If you have restorations to make that can wait, you should pause until you are about to sell your home. Then you may be able to deduct these expenses under the selling costs deduction.
Property Taxes
Property taxes are deductible for homeowners that itemize on Schedule A. The normal deduction for single or joint but filing separately taxpayers is $12,400, and $24,800 for married filing jointly.
Should I Contact a Lawyer Regarding My Tax Issues?
With the plethora of tax software out there, most individuals can do their taxes independently. More sophisticated and more complex tax returns (i.e., those done by business owners) may require more time and perhaps the advice of a lawyer.
Additionally, should you have a dispute with the taxing authority, you may need to go to court, and then a tax lawyer may be required.
