Not all interest is deductible. Mortgage and home-equity loan interest is deductible up to certain limits, but interest on consumer loans, such as auto loans and credit cards, cannot be written off. Interest on loans for business purposes is generally deductible against that income. Interest paid on loans to hold investment property is also generally deductible.

However, you have to understand how investment property is classified for tax purposes. Investment

property includes things like raw land, stocks, bonds and royalty interests. It does not include your principal residence, second home, rental income property, or property used in your trade or business.

Just because investment property is the collateral for the loan does not necessarily mean the interest is deductible. If you use the loan proceeds for other than investment purposes, then the interest is not deductible. When the loan proceeds are used to purchase a tax-free investment, such as municipal bonds, the interest is also not deductible.

Investment interest is deducted on Schedule A of your tax return. However, you can only deduct investment interest up to the amount of investment income received less any investment expenses. Investment income includes interest, short-term capital gains, and elected long-term capital gains and dividends. You decide whether you want to use your long-term capital gains or dividends to offset the investment interest expense. By doing so, those gains or dividends won't be taxed at preferential rates, so you lose that tax advantage.

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