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The Internal Revenue Service allows several tax benefits for education, including the Lifetime Learning credit, American Opportunity credit and the tuition and fees deduction. When you file your taxes, you can include qualifying educational expenses you pay with loans. However, just because you borrowed money while you're in school doesn't mean the entire amount of the loan qualifies as an educational expense.
Qualifying educational costs for the Lifetime Learning credit and the tuition and fees deduction include tuition and required fees. The American Opportunity credit also includes the costs of books and supplies. For example, if you have to pay a library fee that the school imposes on all students as a condition of enrollment, you can include that expense. No matter what the qualified expense, whether or not you pay for it using money you've borrowed through loans, you can include it when figuring your tax break.
If an expense is not a qualified educational cost, you can't claim a tax credit or deduction for it, regardless of whether or not you took a loan to pay for it. Common non-qualifying costs for the American Opportunity credit, Lifetime Learning credit and tuition and fees deduction include room, board and transportation expenses. For example, imagine you take out an $18,000 loan to pay for $10,000 of tuition and $8,000 of room and board. Only the $10,000 that goes toward the tuition can be used in figuring your tax credit or deduction for the year.
When figuring your educational expenses, you must reduce the amount by your tax-free aid, such as scholarships, fellowships and Pell grants. However, a loan does not count as tax-free aid because you must pay it back. Therefore, you don't have to reduce your qualifying expenses by the amount of loans you take out, even if they are federal loans that qualify for a lower interest rate or interest subsidies.
When it comes to deducting student loan interest, you are allowed to include more expenses than for the other tax deductions. For purposes of this deduction, "qualified educational costs" include not only the required tuition and fees, but also room and board, books, supplies and other needed expenses, like transportation to school. The amount you can include for room and board is the smaller of the school's allowance for room and board or, if the student lives in school housing, the amount actually paid.
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