Tax Time: Ins and Outs of Interest Expenses

Mortgage Interest
This is interest paid on a mortgage used to secure a qualified home (technically called “qualified residence interest”). The home can be your principal residence or one other place, like a vacation home. Generally, your deduction is limited to interest paid on the first $1 million of acquisition debt and up to $100,000 of home equity debt.

Investment Interest
When you borrow money to invest in say, securities or investment real estate, the interest is deductible up to the amount of your “net investment income” for the year. This includes most income items such as royalties, interest, and annuity payments.

Business Interest
Interest paid for business purposes, including debts incurred by a self-employed individual, are fully deductible. Unlike the deductions for mortgage interest and investment interest, there are no annual limits. But you can’t write off any personal interest expenses disguised as business interest.

Personal Interest
Finally, interest that doesn’t fall into any of the three previous categories is treated as personal interest. In virtually all instances, personal interest is not deductible. This includes amounts paid on most credit card debt and car loans. There is, however, a limited exception for interest paid on up to $2,500 of student loan debt, phased out for upper-income taxpayers.
This is a basic overview on tax treatment of various forms of interest expense. It does not account for variations or special rules such as limits on passive activity interest. When in doubt, seek advice for your personal situation.

Khorshed Alam is a practicing CPA and business valuation analyst. He is the presdient and CEO of Alam Accountancy corporation. Check out www.alamcpatax.com or call (408) 445-1120.