There are several types of interest you pay during the year that may be deductible on your personal tax return. The most common are real estate interest, student loan interest, and investment interest.
Real Estate Interest
One of the most beneficial aspects of buying a home is the deductibility of interest paid on your home loan. This not only applies to first mortgages, but also second mortgages, home equity loans, and refinanced mortgages on a first or second home. A house may include such things as boats, mobile homes, or condos, as long as they provide basic living accommodations.
One of the requirements of the real estate interest deduction is that the loan being repaid must actually be secured by your home and you must be legally liable to repay the loan. Therefore, wrap-around mortgages or those otherwise not perfected do not qualify for this deduction. The home or second home must be used for your personal use only and may not used as a rental or for any other business purpose.
There are, however, limits to the amount of interest you may deduct. To fully deduct the interest you pay, you must meet one of three criteria: any interest on 1) a mortgage acquired prior to October 13, 1987 will qualify as being fully deductible; 2) home acquisition debt that totals less than $1 million ($500,000 if filing separately); or 3) home equity debt that totals less than $100,000 ($50,000 if filing separately).
Student Loan Interest
If your modified adjusted gross income (MAGI) is less than $65,000 ($135,000 if married filing jointly), you may qualify to claim a student loan interest deduction and reduce your taxable income by up to $2,500.
In order to claim this deduction, the student must be yourself, your spouse, or your dependent and must be enrolled at least half-time in a degree plan. However, you can not claim interest on a loan made from a related person or relative.
The loan must be used for qualified education expenses, which include tuition, room and board, books and supplies, and other necessary expenses. The expenses must also be used to pay an eligible educational institution as defined by the Department of Education.
If your income is $50,000 or less ($100,000 if married filing jointly), then you can claim $2,500 or the amount of interest you paid (in 2005), whichever is less. However, if your income is between $50,000 and $65,000 ($100,000 and $135,000 is married filing jointly), the deduction is reduced. Higher income levels than these discussed eliminate the ability to take the deduction.
Investment Interest
You may be able to receive a deduction on certain interest paid for investment purposes. Basically, if you borrow money to purchase property you hold for an investment, the interest you pay on the loan is investment interest.
For the most part, the investment interest deduction is limited to your net investment income, but there are other limitations depending on the investment vehicle.