For the most part, it’s assumed that liabilities are a bad thing, with no real redeeming qualities. However, there are times when having a liability can come with benefits. One of those times is tax time.
There are three different types of liabilities that come with tax advantages. These liabilities are considered “good” by many, and, as a result, are encouraged through tax deductions.
1. Mortgage Loans
If you buy a home using a mortgage (most of us have to borrow in order to buy a home), you can deduct the interest that you pay. The mortgage interest tax deduction is an itemized deduction, though. This means that not every homeowner can take advantage of it. In order to get a mortgage interest tax deduction, you need to be willing to itemize. Add up your potential mortgage deduction with other itemized deductions, such as charitable giving and unreimbursed medical expenses, to see if your total exceeds the standard deduction.
Also, realize that the mortgage interest tax deduction can also apply to home equity loans and even points you pay when you refinance. Check with a tax professional to ensure that you meet the qualifications for the mortgage interest tax deduction.
2. Student Loans
Did you need to borrow in order to afford school? If so, you might be eligible for a tax deduction for the interest you pay on your student loans. Unlike the mortgage deduction, which requires you to itemize, the student loan interest deduction is an above-the-line deduction. This means that you don’t have to itemize in order to take advantage of this reduction in your income.
There are phaseouts with this deduction, and you are limited to deducting $2,500, but that’s still not too bad.
3. Business Loans
If you own a business, and you pay interest on business loans, you can usually deduct the amount that you pay from your income. This includes the interest you pay on bank loans, credit cards, lines of credit, real estate, cars, and even personal loans. As long as you use the money for business, the interest you pay can be deducted — even if you use personal property as collateral for the loan.
It’s important to understand, though, that the borrowed funds have to be used for business-related expenses. You can’t borrow the money, and then put it in a business account to sit while you take a tax deduction for the interest you pay. The borrowed money has to be spent, and it has to be spent on something related to your business. You can take advantage of this tax deduction no matter what business organization you have, including if you are a sole proprietor (report the interest paid on Schedule C).
While you don’t want to have a liability just for a tax deduction, the reality is that you can benefit from certain types. The cost of some kinds of liabilities can be offset with the help of a tax deduction. Carefully consider your situation, and consult with a financial professional, to help you determine whether or not you can take advantage of certain deductions, as well as whether or not it makes sense to pay off other types of liabilities first, while you reap the tax advantages of mortgage, student, or business loans.