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Student loans and tax deduction

Chris Farrell Sep 30, 2010

Question: I recently got married and inherited a student loan. Lets say its 22k with 5k of capitalized interest. My understanding is that I can claim $2500 of paid interest on my taxes. Am I better off paying off the $2500 each year (until the interest has been paid off) to reap the write off benefits or just paying off the entire loan ASAP? Ben, Torrance, CA

Answer: The value of interest deductions–whether it’s for a mortgage or a student loan– is greatly oversold. Don’t get me wrong. It’s a nice benefit that Uncle Sam reduces the interest cost on debt. But there’s no real gain to reap: The value of the deduction is swamped by the overall interest tab on the loan.

Remember, it’s a deduction, which only reduces your taxable income (as opposed to a tax credit which actually reduces the amount of tax that must be paid.)

With student loans the maximum that you can deduct on your federal taxes is $2,500. As with most deductions, however, there are restrictions on taking advantage of it. For instance, deductions are more valuable the higher your income and tax bracket. But the student loan deduction has income limit, too. It phases out depending on your modified adjusted gross income or AGI. The phase out starts when your AGI is over $60,000 ($120,000 married filing jointly) and the phase out ends when your AGI is over $75,000 ($150,000 married filing jointly).

Yes, the deduction eases the financial pain of paying off the student loan. But don’t keep the student loan for the tax break. Get rid of the loan by all means if you can.

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