How Do You Deduct Mortgage and Other Loan Interests?

In most cases, the interest you pay on loans taken to pay for the expenses of your rental property is tax deductible. However, if you took out a loan using your rental property as collateral, but spent the money on personal things, the interest would not be deductible.

Unless you have inherited a property that has been paid for or have been remodeling the home in which you have lived for years, the mortgage interest on your rental property may be one of your biggest expenses. Your monthly mortgage payment is made up of a principal (a direct refund of what was borrowed) and interest (the amount you pay the lender for the privilege of using their money). Unfortunately, you cannot deduct your principal payments as an operating expense.

The interest you pay is tax deductible in the year you pay it. This does not include any private mortgage insurance (PMI) premiums that your lender requires. PMI premiums are likely if you made a low down-payment, since this insurance protects the lender against your default. However, if you prepay PMI premiums for more than one year in advance, you can only deduct a portion of the PMI premiums that apply for each year. At least for the current year, you may not deduct the points you paid for the mortgage since these must ordinarily be repaid over the life of the loan before they can be deducted.

Your interest can also be deducted if you take out a loan to improve the property. The loans you use to repair the property, such as a home equity loan, are treated slightly differently. In these cases, you may deduct the interest paid and the principal amount during your repayment period.

Finally, interest paid on your business credit card can be deducted. You can also deduct interest on a car loan if you use your personal car for business by simply determining what percentage of the total usage time you use the car for business and then deduct that percentage of the loan interest.