Student Loan Interest

Drop Fees - student loans
Today TaxMama® hears from Sheronda in the TaxQuips Forum, with this common issue (edited). “Taxpayer paid off her student loan using a home equity line of credit (HELOC)? Is the interest still deductible?”

                                                                          

Dear Sheronda and family,

This is a common question. These days, student loans get higher and higher as educational institutions keep raising their fees. It’s hard to get through college without going into debt. All too often, students default on those loans. When they do, the IRS can step in to grab the students’ tax refunds. And you cannot bankrupt student debt anymore.

To make life easier, students and/or their families often take out home equity debt to pay the loan off. The advantages are a lower interest rate – and a longer pay-off period.

The trade-off is that you lose the deduction for the student loan interest. But as Mike Reed, EA points out, the out of pocket cash savings from the lower interest rate far outweighs the tax benefit. In addition, if the HELOC is on the student’s own home, they might be able to deduct all the interest (on a loan of up to $100,000), instead of only the $2,500 deduction available for student loans.

One more way to deal with student loans. There are a variety of government and exempt organization programs that will cancel the loan. This is a tax-free benefit students can get in exchange for providing health or educational services in a variety of off-the-beaten path areas. Think of Dr. Joel Fleishman stationed in Alaska in Northern Exposure.

And remember, you can find answers to all kinds of questions about student loans and other tax and business issues, free. Where? Where else? At www.TaxMama.com.

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One thought on “Student Loan Interest

  1. ShortStuff says:

    Sorry, do not agree with TaxMama. As long as the home equity loan was used only to take out the education loan it is deductible education interest. It does not have to be a “Education Loan” received from lenders who specialize in that type of loan. Please see Reg 1.221-1 (E)(3) and (E)(4). Particularly examples under (E)(4) #3 where the student borrows from a commercial bank and #6 where a home equity loan was used. #6 fails only because it was a mixed use loan. If it had been used only for the education expenses it would have qualified. Have coped the examples to below:

    (4) Examples. The following examples illustrate the rules of this paragraph (e):

    Example 3. Qualified education loan. Student H borrows money from a commercial bank to pay qualified higher education expenses related to his enrollment on a half-time basis in a graduate program at an eligible educational institution. Student H uses all the loan proceeds to pay qualified higher education expenses incurred within a reasonable period of time after incurring the indebtedness. The loan is not federally guaranteed. The commercial bank is not related to Student H within the meaning of section 267(b) or 707(b)(1). Student H’s loan is a qualified education loan within the meaning of section 221.

    Example 6. Mixed-use loans. Student J signs a promissory note for a loan secured by Student J’s personal residence. Student J will use part of the loan proceeds to pay for certain improvements to Student J’s residence and part of the loan proceeds to pay qualified higher education expenses of Student J’s spouse. Because Student J obtains the loan not solely to pay qualified higher education expenses, the loan is not a qualified education loan.

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