The federal income tax law does provide taxpayers with a number of opportunities to deduct the interest when repaying a loan. Interest paid on credit cards can be deducted on your tax return only if the charges cover certain types of expenses. But if you're like most people who mainly use credit cards to purchase consumer goods and services, a large portion of the interest paid is nondeductible.
How Interest Deductions Work
As a general rule, credit card interest, as well as the interest charges you pay on other borrowings, isn't deductible unless a specific provision in the tax code allows for it. Interest you pay on a student loan, a mortgage, on the money you borrow to purchase investments or to pay business and rental property expenses with are all deductible. Although you can't deduct the interest when using a credit card to put yourself through school or to purchase a home, you can when using the card for these other purposes. But even if you use a credit card for an expense for which an interest deduction is permitted, you must be personally liable to the credit card company for repayment of your charges to be able to deduct the interest.
Charging Personal Items on Credit Card
When you use a credit card to purchase personal items, such as a car, groceries, clothes or anything else that's unrelated to a business, rental unit or investments, all of the interest is nondeductible. The principle reason for this tax treatment is because the cost of purchasing personal items are never deductible either.
Borrowing to Acquire Investments
Using a credit card -- including cash advances -- to purchase investments allows you to deduct the related interest. The investments you purchase, however, must be income-producing property, such as stocks and bonds. Your credit card interest deduction, however, cannot be more than the “net investment income” reported on the same tax return. Net investment income is the amount remaining after subtracting all non-interest investment expenses from your investment income. Investment income covers royalties, interest, dividends and even the profit you earn from selling an investment at a higher price than you originally paid. Investment expenses include most costs you incur to choose, purchase, manage and sell your investments, such as the fees you pay to an adviser and certain transaction charges, as well as many others.
Credit Cards Used for Business and Rentals
If you run a business of any size or own real estate that provides you with rental income, the interest paid on the charged expenses related to either activity is fully deductible. With a business, for example, it doesn't matter specifically what you buy, but whether it's an ordinary and necessary business expense. When you use a credit card exclusively for business-related charges, 100 percent of the interest is deductible. But if you use the card for both business and personal purposes, you can only deduct the interest that accrues on the business charges -- which means you may have to gather all of your credit card statements and separate the business charges from the personal ones when it's time to prepare your income tax return.
Michael Marz has worked in the financial sector since 2002, specializing in wealth and estate planning. After spending six years working for a large investment bank and an accounting firm, Marz is now self-employed as a consultant, focusing on complex estate and gift tax compliance and planning.