At first, debt and taxes may seem unrelated. But some types of debt, like student loans and mortgages, can actually lower your taxable income. Knowing how your debt affects your taxes can help you maximize your savings at tax time.
Is debt tax deductible?
When it comes to taxes, not all debt is created equal. The IRS allows deductions for certain types of debt, but the rules vary. For example, mortgage interest is generally tax-deductible, and interest on money borrowed to invest in property or securities like stocks and mutual funds may also be deductible, within certain limits. On the other hand, consumer debt, such as credit card interest, is typically not deductible.
You may also hear the terms recourse and nonrecourse debt. With recourse debt, you’re personally responsible for the loan, so if you don’t pay, the lender can go after your other assets. With nonrecourse debt, the lender can only take the asset tied to the loan.
This difference matters for risk and some tax situations, but it usually doesn’t affect whether interest is deductible. What matters most is how you use the money (like for a home, investments, or personal spending), not the type of debt.
What types of debt can I deduct on my tax return?
The interest you pay on your personal debt will either be tax-deductible or nondeductible.
The IRS allows you to deduct certain types of interest on your taxes, including:
- Investment interest
However, interest paid on credit cards and car loans is not deductible.
Student loan interest
College is not cheap. Having to pay a loan as soon as you graduate may seem overwhelming. But it can also provide a welcome tax break. You can deduct up to $2,500 of the interest you pay on qualified education loans for college expenses. You do not have to itemize your deductions to take this tax break. That means you can take this deduction in addition to the standard deduction because it is an above-the-line deduction.
The student is not the only one who can take this tax break. If your filing status is married filing jointly with your spouse, you can still take this deduction. Or, if you are the student’s parent and they qualify as your dependent, you are eligible to take this deduction.
For taxes filed in 2025, the deduction phases out when your AGI reaches $90,000 for individuals and $185,000 for married couples filing jointly. For taxes filed in 2026, it phases out at $95,000 for individuals and $195,000 for married couples filing jointly.
Mortgage interest
The mortgage interest deduction is a tax deduction for interest paid on the first $750,000 of mortgage debt. This deduction allows you to reduce your taxable income by the amount of money you paid in mortgage interest during the year. Claiming the mortgage interest deduction requires you to itemize your deductions.
Investment interest
The interest you pay on borrowed money, in most cases, is tax-deductible.
For your investment interest to be deductible, the investment has to be designed to produce taxable income. For example, a loan that allows you to invest in stocks or bonds will be tax deductible.
However, the IRS limits how much of this interest you can deduct on your tax return. The deduction is restricted to the amount of taxable investment income you report. Investment income can be:
- Interest
- Annuities
- Royalties
If the amount of interest you wish to deduct exceeds the limit, you can carry the excess over to your next tax return as long as you have sufficient investment income to offset it.
Does credit card debt affect my tax return?
Credit card debt generally does not affect your tax return. The interest you pay on personal credit card debt is not tax-deductible. However, there are exceptions where credit card debt can impact your taxes. If you have canceled or forgiven credit card debt, that may be considered taxable income.
Is forgiven debt taxable?
Yes. If a creditor forgives $600 or more of your debt, they are required to issue a Form 1099-C, and you must report that amount as income on your tax return. This could include forgiveness from credit cards, personal loans, or even some student loans.
Note: If you were insolvent, meaning your liabilities exceeded your assets, at the time the debt was canceled, you might qualify for an exclusion and not have to pay taxes on the forgiven amount.
How does the IRS classify forgiven debt?
The IRS classifies forgiven debt as taxable income because you never paid it back. Think of getting a loan as entering into a contractual agreement. If the contract gets canceled without you paying back the loan, then this is considered taxable income.
But, if you had debt forgiven in the event of bankruptcy, then you don’t have to pay taxes on the debt. Canceled debt must be reported on your tax return the year the cancellation occurs.
What types of canceled debt are not taxable?
Debt that has been erased for any of the following reasons is not taxable:
- Amounts canceled as gifts, bequests, devises, or inheritances
- Certain qualified student loans
- Certain other education loan repayment or forgiveness programs to help provide health services
- Amounts of canceled debt are deductible if you, as a cash basis taxpayer, paid it
- A qualified purchase price reduction given by the seller of property to the buyer
- Any Pay-for-Performance Success Payments that reduce the principal balance of your home mortgageAmounts from student loans discharged on the account of death or total and permanent disability of the student
You can also exclude debt from your gross income depending on your financial circumstances.
