The Tax Implications of Some Debt Reduction Strategies

When analyzing financing options or debt relief issues many people forget to include the tax implications of one strategy over another. Including tax implications in your scenarios can become very complicated, which is why it is always handy to have a computer program such as Quicken to help you crunch the numbers.

Here are a few simple guidelines to keep in mind.

In the U.S., the biggest tax write-off for many individuals is the interest paid on a property loan. Since they represent large debts, paid over many years, the interest is (for several years) the overwhelming majority of the total monthly payment. As a result, much of that interest paid can offset taxable income.

But there are other tax issues involved with other forms of debt that should be factored into planning.

Taking out a home equity loan used to be primarily for the purpose of making improvements to the property. Many people these days use that money for a much wider variety of goals. A HELOC (Home Equity Line of Credit) can be used to finance just about anything - an auto purchase, repayment of credit card debt… you name it.

One advantage of this type of debt is precisely the tax benefit. Just as with a primary loan, interest on a second mortgage or a HELOC is tax deductible. So, even when the interest rate is the same as a credit card (and they are often lower), the net result can be beneficial.

The only way to know for sure in your circumstances is to do the calculations. Online loan calculators are readily available that will help you do just that. Run through several scenarios to decide the effect in your case.

It’s possible to obtain a loan to pay for large medical costs. Some people pay for such things with a credit card, which is possibly the most expensive way to finance the debt. Sometimes that’s necessary; no ‘one-size-fits-all’ recommendation is possible.

Since much of the interest on such loans, and sometimes the medical expenses themselves, is tax deductible it can be worthwhile to finance the costs that way.

Interest on or amount paid to student loans, too, is tax deductible up to a point. Your circumstances will vary from another’s. Tax filing software is probably your best bet for calculating the pros and cons in your individual case. As you answer the ‘interview questions’ you can put in the amounts and follow the tutorial to determine the impact.

Whatever the example, whenever you are considering assuming debt - especially for large amounts - taking the time to evaluate the tax implications can save you substantial amounts of money. That can easily be worth a couple of extra hours of research, especially since you’ll be able to use that knowledge time and time again.