Tax Treatment of Interest Paid on Loans

There are many reasons why people co-sign loans. These would include situations where several people jointly purchase a property, and instances where one or both parents co-sign a student loan with their child. Although all co-signers are ultimately liable for repayment of the loan, the reality is that in many instances, not every co-signer will make regular, monthly co-payments. If you've co-signed a mortgage loan for a family member who lacks good credit, the person who's actually living in the residence may make the loan payments. In the interest of student loans, parents will often take on the full responsibility for repaying the loan, but will have their child co-sign it to help them start to build a solid credit history.

With this in mind, it's important to understand the Internal Revenue Services' rules regarding the interest deductions of co-signed loans.

Student Loans

The Internal Revenue Service treats interest paid on student loans differently than other interest expenses. Unlike other interest, student loan interest is not itemized on your tax return, which means it can be deducted regardless of whether you itemize or use the standard deduction, provided your adjusted gross income is less than $65,000 or $135,000 if filing jointly (for 2007 tax year).

However, some unique rules apply to student loan interest. Student loan interest expense (up to a maximum of $2,500) can only be deducted if the student is:

• The taxpayer who took out the loan
• The taxpayer's spouse
• The taxpayer's dependent

Students who are dependents on their parent's tax return cannot deduct the interest expense on their tax return. For practical purposes, this means that if the parents and student co-sign a student loan, only the student (if he or she isn't claimed as a dependent on his parents' tax return) or the parents (if they claim the student) may deduct the interest.

Mortgage and Investment Interest

Under IRS rules, interest paid on mortgages and other loans is deductible if the taxpayer itemizes his or her deductions. When two or more people co-sign a loan, the IRS requires that borrowers only deduct interest that they actually paid on the loan. For example, if two people co-signed a loan but Person A makes 100% of the payments, then only Person A may deduct the interest. If Person A makes 30% of the payments and Person B makes 70% of the payments, then Person A will deduct 30% of the interest and Person B will deduct 70% of the interest. If Person A and Person B each make 50% of the payments, but only Person A itemizes his tax deductions, then only Person A can deduct the interest expense (and can only deduct the 50% of the interest expense that he paid).

Questions for Your Attorney

• Can I itemize interest paid on student loans for my federal taxes?
• If I took out loans to go college, can I deduct the interest that I paid on the loans?
• If my father and I co-signed college loans, how much of the interest can I deduct on my taxes?

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