Can I take a tax deduction for interest on my tax return?

Interest tax deductions fall into one of six categories:

Whether your interest is tax deductible on your tax return depends on how you borrowed the funds and how the funds were used. Investment interest, which is any interest incurred to buy or carry investment property, is tax deductible on your tax return up to the amount of your net investment income. Home mortgage interest is described below. Trade or Business interest is usually fully tax deductible on your tax return. Passive activity interest is subject to the passive activity loss limitations. Student loan interest is partially tax deductible on your tax return and personal interest, which includes interest paid on car loans, credit cards, and personal loans, is not tax deductible at all on your tax return.

If you prepay interest, you must allocate the interest over the tax years to which it applies. You may deduct on your tax return for each tax year only the interest that applies to that tax year.

The types of interest you can deduct on your tax return on Schedule A of Form 1040 are investment interest, certain home mortgage interest, and points in some cases.

Home mortgage interest is interest you pay on a loan secured by your main home or a second home. The loan may be a mortgage to buy your home, a second mortgage, a home equity loan, or line of credit.

Your main home is where you spend most of your time. It can be a house, cooperative apartment, condominium, mobile home or houseboat that has sleeping, cooking and toilet facilities.

Home mortgage interest and points are generally reported to you on Form 1098, Mortgage Interest Statement by the financial institution to which you made the payments.

If all of your mortgages fit into one or more of the following three categories at all times during the tax year, you can deduct on your tax return all of the interest on these mortgages.

If one or more of your mortgages does not fit into any of these categories, get IRS Publication 936, Home Mortgage Interest Deduction, to figure the amount of interest you can deduct on your tax return.

Items you cannot deduct on your tax return as interest include points, if you are a seller, service charges, credit investigation fees, interest relating to tax-exempt income, and interest to purchase or carry tax-exempt securities.

Home equity interest generally is not tax deductible on your tax return for AMT purposes unless the borrowed funds are used to buy, construct, or substantially improve a principal or, in certain cases, a second residence. In refinancing an existing mortgage or considering a home equity loan, be aware of the loan costs that will be incurred. In most cases, points or other interest charges paid to refinance an existing mortgage cannot be immediately deducted on your tax return, but rather they are deducted on your tax return on a pro rata basis over the life of the loan.