Taxpayers can either directly deduct an expenses from AGI or they must itemize the deduction according to tax laws. Interest expenses are treated differently for tax deductions depending on what type of interest expense is being deducted by the taxpayer. Whether interest is deductible for AGI or as a limited itemized deduction depends on whether the indebtedness has a business, investment, or personal purpose.
Rules for Deducting Interest Expense
- If the debt is in relation to a business or for the production of rent or royalty income, the interest is deductible for AGI.
- If the debt is incurred for personal use, such as qualified residence interest, any deduction allowed is taken from AGI and is reported on Schedule A of Form 1040 if the taxpayer elects to itemize.
The main types are interest that taxpayer’s itemize are the following types of interest you can deduct as itemized deductions on Schedule A (Form 1040).
- Home mortgage interest, including certain points and mortgage insurance premiums.
- Investment interest.
Deducting Interest on Student Loans
There is one exception to these debt deduction rules. Interest on student loans is a personal expenses and student loan interest is deducted directly from AGI. Another similar item is that if a taxpayer deposits money in a certificate of deposit (CD) that has a term of one year or less and the interest cannot be withdrawn without penalty, the full amount of the interest must still be included in income, even though part of the interest is forfeited due to an early withdrawal.
Rule for Deducting or Itemizing Interest Expenses
Business expenses are different and interest will be allowed a deduction. Business expenses appear on Schedule C of Form 1040, and expenses related to rents or royalties are reported on Schedule E. Taxpayers should check all statements received by the bank because the IRS can double check to make sure that taxpayers are not taking more interest deductions than they are entitled to take.