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Taxes and Reducing Debt – TheStreet

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Taxes and Reducing Debt – TheStreet



Find tax benefits from homeownership, student loans, and investment interest

With so many people worried about keeping their jobs and keeping up with consumer debt repayments, it’s no wonder that more and more are concerned about reducing debt to manageable levels. The key to reducing debt is just like any other diet: reduce spending, just like cutting calories and exercising — in this case, exercising your self-control. The similarities with typical dietary regimens don’t end there. Remedies are often easier to explain than execution. But once you’re committed to your goals, there are ways to take advantage of the tax code to reduce your debt.

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The interest you pay on consumer debt falls into two distinct categories: tax-deductible and non-tax-deductible. Mortgage interest is generally tax-deductible. There are also restrictions on interest on student loans and money borrowed to buy investment properties, including stocks, bonds, and mutual funds. For tax years prior to 2018, a certain amount of home equity debt is deductible. However, starting in 2018, interest paid on this type of debt is no longer deductible unless it was used to buy, build or substantially improve your home. There is also a limit to the amount of debt for which interest can be deducted.

Interest paid on credit cards and auto loans is not deductible. In theory, using a home equity loan to pay off high-interest credit card debt is a good idea for years (tax years prior to 2018) when there is no limit to your ability to deduct interest on your home equity debt. For example, exchanging $10,000 of 18% non-deductible credit card debt for $10,000 of 7.5% deductible debt reduces after-tax holding costs from $1,800 to $540 per year for 28% of taxpayers.

In fact, this strategy works well if you commit to paying off your home equity debt and claiming tax-deductible interest on your tax return as soon as possible without letting your zero balance credit card statement tempt you to continue. Better yet another shopping spree. Using your home as a piggy bank has its limitations, and even tax-free interest costs money.

Homeowners rejoice

Homeowner tax deductions fall into three categories: when you buy, when you own, and when you sell. Take advantage of these tax deductions, adjust your payroll withholding tax, or if you’re self-employed, reduce your estimated quarterly taxes, and you’ll have more money in your pocket each month to pay off your debt.

For most people, buying a home opens the door to substantial tax breaks in the form of itemized deductions. In 2021, individuals can claim the basic standard deduction of $12,550. For the head of household, the deduction is $18,800. For married couples filing joint returns, the standard deduction is $25,100.

Compare that to a homeowner who might have $12,000 in mortgage interest and $5,000 in local property taxes. In the 25% federal tax bracket, a combined tax deduction of $17,000 could save you $4,250 per year. Save more than $350 a month in taxes and you can file to pay off your debt.

Once you start itemizing your deductions, you can lower your tax bill even further by writing off charitable contributions, state income taxes, and possible medical expenses. More tax savings means more money to pay off debt. By comparison, 25% of singles would save $3,100 in taxes by filing the $12,550 standard deduction in 2021.

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When you own your house, you can borrow against your equity — the difference between what you owe and the value of your home. You can choose a loan for a fixed amount, usually tied to a fixed interest rate, or a line of credit that you can use at will, usually with a variable interest rate. However, interest paid on a home equity loan is subject to specific rules to determine if it is deductible.

Profits of up to $250,000 ($500,000 for married couples filing jointly) are tax-free when you sell your home. Downsizing to a cheaper home, especially for new retirees, can be a great way to free up cash and pay down debt. To receive tax-free profits, you must have owned and lived in the home for at least two of the five years preceding the sale.

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student loan interest

It’s no secret that a college education is getting more expensive. This is one of the largest debts faced by recent college graduates or their families. The good news is that you can deduct up to $2,500 in qualified education loan interest to pay for college or vocational school, whether you itemize the deduction or not, subject to income limits. This tax deduction is called an “offline deduction” and can reduce the amount of your taxable income. The deduction can be used for loans to pay for education expenses for you, your spouse, or dependents.

By 2021, the deduction will be phased out when the adjusted gross personal income is between $70,000 and $85,000 and the adjusted gross income for married couples filing jointly is between $140,000 and $170,000.

investment interest

The old adage “you have to spend money to make money” has a corollary. Sometimes “you have to borrow money to invest”. If you do, the interest you pay on the borrowed money is tax-deductible in most cases.

In order for interest to be deductible, the investment must be designed to generate taxable income. For example, interest on margin loans offered by your broker to invest in stocks or taxable bonds is eligible. But if the borrowed money is used to invest in tax-exempt securities, the interest is not deductible. The same is true if you borrow money to buy a single premium life insurance policy or annuity. Congress doesn’t want IRS subsidized loans to help you buy tax-advantaged investments.

But there is a limit to how much investment interest you can deduct. Write-offs are limited to the amount of taxable investment income you report. Investment income is defined as interest, annuities or royalties, but does not include net capital gains or qualifying dividends. (If your gains are taxed at a top rate of 20%, the government doesn’t necessarily want you to deduct investment interest in the regular tax bracket that could be as high as 37% in 2021.) However, any interest you can’t deduct because the hat won’t last forever lost. It may be carried forward and deducted in future years once there is enough investment income to offset it, or on your final tax return after your death.

Remember, with TurboTax, we’ll ask you simple questions about your life and help you fill out all the correct tax forms. With TurboTax, you can be confident that your taxes are correct, no matter your situation, from simple to complex tax returns.

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