The IRS allows you to deduct certain expenses from your total income to arrive at taxable income, which is the portion of your earnings that is subject to tax. Some of these expenses include your payments of interest on a mortgage and for business loans. However, when you use a credit card for personal purchases, the interest you pay is nondeductible personal interest.
What is personal interest
Personal interest is interest you pay for goods and services you don't use for work or business-related purposes. Although not an exhaustive list, common examples include buying clothes, electronic equipment, cars and food using a credit card. When you make monthly payments that include interest, it is always nondeductible personal interest. This remains true even if you use the credit card to subsidize the purchase of your home.
Deductible credit card interest
One exception to the rule is if you use a credit card for business purposes. Generally many companies, whether a corporation or sole proprietorship, use credit cards to purchase equipment for use in the business, to buy necessary supplies and for many other daily transactions. When you use a credit card in this way, the interest payments you make on the credit card are deductible as a business expense. This means that you can reduce the amount of your business earnings that are subject to tax for these interest payments. However, if you use the credit card for both business and personal purposes, you need to insure that you only deduct the interest that accrues on the business-related purchases.
History of credit card interest deduction
The Tax Reform Act of 1986 changed many provisions in the Internal Revenue Code. One of the most notable was the elimination of the personal interest deduction. Prior to this, you could deduct all credit card interest payments, regardless of what you purchased.
Ways to avoid nondeductible credit card interest
Sometimes it may be possible to claim an interest deduction for your purchase by using a payment method other than credit cards. For example, instead of using your credit card to pay your school tuition this semester, you may want to look into student loans first. When you use a student loan, the IRS allows you to deduct the interest payments you make on it until it's paid off. For tax years prior to 2018, the interest on a home equity loan was deductible and could provide cash to make personal purchases and also allowed you to deduct the interest as part of your mortgage interest deduction. However, beginning in 2018, home equity loan interest is not deductible unless it is used to buy, build, or substantially improve your home.
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