Deducting Interest

YOU CAN POTENTIALLY take a tax deduction for the interest on the three types of loan: mortgages, education loans and margin debt. Education loans are discussed in the money guide’s college chapter.

Suppose you take out a loan costing 6% and you’re in the 24% federal income tax bracket. If the interest is tax-deductible, your after-tax cost is just 4.56%. Keep that tax-deductibility in mind as you consider how best to borrow. Tax deductibility also comes into play as you weigh which debts to pay down first or whether, instead, you should invest your spare cash.

Under the 2017 tax law, you can deduct the interest on up to $750,000 borrowed to buy, build or improve a first or second home. You used to be able to deduct the interest on an additional $100,000 of home equity borrowing used for any other purpose, but that deduction was nixed by the 2017 law.

The interest on loans used to buy taxable investments remains tax-deductible. In other words, you can take out a margin loan against your portfolio’s value and deduct the interest if you buy stocks—but you can’t deduct the interest if you use the money to buy municipal bonds or a new car. An important detail: You need to offset deductible investment interest against net investment income. The latter includes taxable interest that you earned, and perhaps also dividends and realized capital gains.

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