It depends. Generally, the tax law requires you to allocate interest payments under a complex set of rules. The tax results vary, based on whether the expense is characterized as mortgage interest, investment interest, business interest, or personal interest.
- Mortgage interest: This is interest paid on a mortgage used to secure a qualified home (technically called “qualified residence interest”). The home can be your principal residence or one other place, like a vacation home. Generally, your deduction is limited to interest paid on the first $1 million of acquisition debt and up to $100,000 of home equity debt.
- Investment interest: When you borrow money to invest in say, securities or investment real estate, the interest is deductible up to the amount of your “net investment income” for the year. This includes most income items such as royalties, interest, and annuity payments.
- Business interest: Interest paid for business purposes, including debts incurred by a self-employed individual, are fully deductible. Unlike the deductions for mortgage interest and investment interest, there are no annual limits. But you can’t write off any personal interest expenses the IRS deems is disguised as business interest.
- Personal interest: Finally, interest that doesn’t fall into any of the three previous categories is treated as personal interest. In virtually all instances, personal interest is not deductible. This includes amounts paid on most credit card debt and car loans. There is, however, a limited exception for interest paid on up to $2,500 of student loan debt, phased out for upper-income taxpayers.
This is a basic overview on tax treatment of various forms of interest expense. It does not account for variations or special rules such as limits on passive activity interest.