You may not associate taxes with your current debt because you are usually taxed on your income. But your debt can have a positive effect on your taxes. Learn more about how to use your debt to earn credits and deductions back on your taxes below.
Reducing debt and your taxes
One monthly expense most taxpayers have is debt of some form. Many people are focused on reducing their debt via monthly payments. They do this by setting goals for themselves. When you are actively paying down your debt, there are ways you can use certain tax breaks to slim down your debt exponentially.
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:
- Student loan interest
- Mortgage interest
- 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 2021, the deduction phases out when your AGI reaches $85,000 for individuals and $170,000 for married couples filing jointly.
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.
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:
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.
This information in this article is up to date for tax year 2020 (taxes filed in 2021).