While repayments on most loans aren’t tax deductible, there are some exceptions. Knowing your way around these exceptions is key for reducing your tax bill and maximizing your annual revenue.
A professional tax service will be able to assist you in managing your tax returns to ensure you are managing your finances in the most cost-effective way. However, as a general rule, these three types of personal loans are usually tax-deductible, meaning you are not taxed on the payments made to borrowers. As always, check with your local tax authority before filing to ensure your debts meet the criteria.
Student Loans
While you are making payments on outstanding student loans, you are able to deduct up to $2,500 of interest per year. This is only applicable if your student loans are with an approved lender (private loans from family members or friends do not fall into this category).
The IRS has a useful tax assistant tool to tell you if you are eligible to deduct the interest you paid towards a student loan on from your tax returns.
Business Loans
If you used a loan entirely for business and did not make any purchases with the money that could be considered a personal expense, then your business loan interest repayments can be deducted from your taxes.
For loans that were partly used for business purposes and partly for personal, you are able to deduct the interest repayments on the percentage of the loan you used for business purposes but will not be able to deduct the interest repayments on the percentage of the loan you used for personal purchases.
Mortgages or Other Secured Loans Using Your Property as Collateral
Interest payments on mortgages and Home Equity loans, which use your property as collateral, can be deducted on the first $750,000, even if it is your second mortgage. Providing you used the loan for property improvements, buying a property, or building your home, any form of home equity loan also falls under this category.
If you are married and filing your taxes separately, you can only deduct interest on the first $350,000 of a mortgage or home equity loan.
How Does This Benefit Me?
Consider this scenario. You earn $100,000 in taxable income each year. Every year you pay $10,000 of interest on your mortgage, another $5,000 in interest on your student loans, and $5,000 in interest on a business loan.
This means that you would be paying $20,000 of interest on loans each year. This is tax deductible, which means that it would reduce your total taxable income from $100,000 to $80,000. Annual earnings of $80,000 are taxed at a rate of 22%, while earnings of $100,000 are taxed at 24%. This means that you would shave almost $5,000 off your annual tax bill, a significant savings.
By being aware of your annual interest payments on these types of loans, you can effectively manage your tax bill. Managing your money effectively in this way will have significant financial ramifications over the course of your adult life.
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