Unless your loan qualifies for a specific deduction, bank loan interest can't be used to reduce your tax bill because it counts as personal interest. If the loan does qualify, you must be the one who's legally liable for the loan. If you're just paying a loan on someone else's behalf, you can't deduct it.
If you take out a loan to invest money, the interest qualifies as investment interest, which is deductible, but only if you itemize your deductions. For example, if you borrow money to buy stocks or bonds, also known as "trading on margin," that interest qualifies. However, you can't deduct the interest if you're generating tax-exempt income. For example, interest on certain state bonds isn't taxable, so if you're buying those with the proceeds of your loan, the loan interest isn't deductible. Plus, your deduction is limited to your net investment income for the year, so if your investment isn't paying off yet, you have to carry forward your interest paid to a future year when you have investment income to offset.
Home Mortgage Interest
If your bank loan is secured by your residence, you can deduct the interest as either home acquisition debt or home equity debt. Home acquisition debt includes loans you used to buy or substantially improve your home, such as a loan to add on a garage. Home equity debt can be used for anything as long as it's secured by your home. The difference is you can deduct the interest on up to $1 million of acquisition debt but only the interest on $100,000 of home equity debt. If you're married filing separately, these limits are halved for each spouse.
If you've got your own business, you can write off the interest on a bank loan used to fund your company. For example, say you opened your own grocery store and use a bank loan for inventory and other costs. You can deduct all the interest you pay as a business expense. Similarly, if you take out a mortgage to buy a store, you can also so can deduct the interest as a business expense.
Student Loan Interest
You can also deduct up to $2,500 of interest if the bank loan counts as a student loan. For the loan to qualify, you must have used all the proceeds to pay for higher education expenses for you, your spouse or your dependent. Higher education includes college, graduate school, trade school and vocational school. However, to qualify, your modified adjusted gross income can't exceed the annual limits -- $75,000 for single filers and $150,000 for joint filers as of the 2012 tax year.
- Internal Revenue Service: Topic 505 -- Interest Expense
- Internal Revenue Service: Publication 550 -- Investment Income and Expenses
- Internal Revenue Service: Publication 936 -- Home Mortgage Interest Deduction
- Internal Revenue Service: Publication 935 -- Business Expenses
- Internal Revenue Service: Publication 970 -- Tax Benefits for Education
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."