What types of interest payments are tax deductible?

The question of what types of interest payments are tax deductible very complicated. The general rule is that interest payments are tax deductible, but there are many exceptions to consider when filing taxes.

Investment Interest and Tax Deductions

One exception to the general rule that interest is tax deductible is investment interest. Investment interest payments are paid on indebtedness properly allocable to property held for investment, such as stocks held on margin, loans to others, etc. Investment interest also includes interest payments on real property rentals if the taxpayer actively participates in the activity. Passive real estate rentals are subject to a separate disallowance rule relating to passive activity losses. Investment interest is tax deductible by individuals only to the extent of investment income. Investment income means interest from investment property, including net capital gains. Examples of investment income include interest received and dividends.

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Personal Interest and Tax Deductions

Personal interest payments are not tax deductible. Personal interest is defined as all interest except trade or business interest, investment interest, qualified residence interest (discussed in the following paragraph) and interest taken into account as part of the passive activity rules. This is why it might appear that the exceptions are consuming the rule.

Qualified Residence Interest and Tax Deductions

Qualified residence interest payments can be tax deductible and include the interest on a mortgage securing a principal residence or one other residence, such as a beach house, mobile home, a condo, or mountain cabin, the proceeds of which were used to acquire the residence.

The deduction for home mortgage interest was limited by the Tax Cuts and Jobs Act of 2017. For home contracts taken out after December 15, 2017, only interest on the first $750,000 ($375,000 for married filing separately) is deductible, down from $1,000,000. If you bought a home before December 15, 2017, the $1,000,000 limit remains. This change  reverts to the previous limit of $1,000,000 beginning in 2026, regardless of when the home contract was executed.

Home equity debt: From 2018 through 2025, the home equity loan interest deduction is gone.

Under pre-2018 law, qualified residence interest includes interest on any debt secured by a principal or the other residence, but not in excess of the fair market value of the residence less the acquisition debt. This other debt is limited to $100,000. The net result is that interest on debt secured by a qualified residence cannot exceed the value of the residence for a tax deduction, in addition to the $1,000,000 and $100,000 limits.

Getting Legal Help with Tax Deductible Interest Payments

Knowing what interest payments are tax deductible can be difficult as the law is complicated and littered with exceptions.  Consult an experienced tax attorney to properly deduct interest payments from your taxes.

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Case Studies: Understanding Tax Deductible Interest Payments

Case Study 1: Investment Interest Deduction

John is an investor who buys stocks on margin. He incurs interest expenses on the funds borrowed to purchase these stocks. Since the interest payments are directly related to his investment activities, John can deduct them as investment interest. However, the deduction is limited to the amount of investment income he earns, such as dividends and interest from investment property.

Case Study 2: Qualified Residence Interest Deduction

Sarah and Michael recently purchased a new home using a mortgage. The interest payments on their mortgage may be tax deductible as qualified residence interest. They can deduct the interest on the first $750,000 of their mortgage debt if the home contract was taken out after December 15, 2017.

If their mortgage was executed before that date, the deduction is limited to the first $1,000,000 of debt. It’s important for Sarah and Michael to keep accurate records of their mortgage interest payments to claim this deduction.

Case Study 3: Personal Interest Disallowance

Emily took out a personal loan to finance a vacation. The interest payments on this personal loan are not tax deductible. Personal interest, which includes interest on personal loans, credit card debt, and auto loans, is generally not eligible for a tax deduction. Emily should be aware that personal interest payments cannot be used to lower her taxable income.

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