How Debt Can Actually Lower Your Taxes

Debt is not necessarily the most terrible thing ever. Sometimes, debt is a good thing — it can help you fund college, build credit and can even help you save money on your taxes.

Taking on debt can be beneficial in many ways — student loans are an investment in your future, for example — and sometimes that means a tax break. This is the part where you can get (a little) excited about tallying up interest you paid on some of your debts last year. Not all loan interest corresponds with a tax deduction, but it’s important to see if you qualify for one. After all, who doesn’t like saving money?

A lot of these deductions are straightforward, but they also have some limits. If you’re unsure whether you meet the requirements for a certain deduction, you should consult with a tax professional before plugging the numbers into your tax return. And you better hurry up!

Student Loans

Let’s keep with the student loan example: If you’re in repayment, your loan servicer or servicers will issue you an IRS Form 1098-E, on which it will show how much of your loan payments in the last year went toward interest. How much you get depends on a few things, said Mark Luscombe, principal federal tax analyst for Wolters Kluwer, CCH.

You can deduct a maximum of $2,500 per year, but that limit could be lower (or zero), depending in your income.

Mortgages

Interest on a home loan is deductible, as long as the principal balance of the loan does not exceed $1 million. The same goes for loans used to construct or remodel a home. You can claim this deduction for up to two mortgages.

HELOCs

If you use a home equity line of credit for something other than home improvement, you can still deduct interest on a HELOC, but the maximum principal in this case is $100,000.

Business Debt

If you carry a balance on a business credit card, that interest can be tax deductible.

“Anyone that utilizes a credit card for business expenses whether they are freelance, small business or partnership/corporation can deduct the interest and bank fees incurred in these transactions,” said Vincenzo Villamena, a certified public accountant (CPA) and managing partner of Online Taxman, in an email to Credit.com.

If you took out a loan for business expenses, you can write off that interest, as well, Luscombe said.

Investments With Borrowed Money

If you invest with borrowed money, known as investing on margin, the interest you pay on your margin balance is tax deductible.

The nice thing here is that if you’re not familiar with any of these products, you probably don’t have them and therefore do not need to be concerned with their associated tax deductions. Keep these in mind if you take on any of these debts in coming tax years so you can take appropriate advantage of them, but you’ll want to watch out for any tax law changes that may pop up in the meantime.

A final note: If you have a high income level, you could be subject to the alternative minimum tax, which takes away some of these and other tax deductions, because some tax benefits significantly reduce a taxpayer’s regular tax amount. The AMT was designed to keep high-income earners from avoiding income tax by loading up on deductions, and there are tools online you can use to find out if you’ll fall into this category.