Can I Deduct Interest Paid on a Defaulted Student Loan?

The student loan interest deduction allows you to write off interest paid during the entire year. You can deduct student loan interest you paid regardless of what happens after you make the payment, even if you default on the loan later that same year. For example, if you made your student loan payments during the year through June and then defaulted on the loan and made no more payments, you could deduct the interest you paid through June. This amount should be reported to you on a Form 1098-E.

If you do not actually pay the interest, but the interest is added to your account balance, also known as the interest being capitalized, you can’t claim a deduction. For example, assume you owe $10,000 on your student loans. If you missed three student loan payments before you defaulted, and as a result $600 in interest that wasn’t paid was added to your balance due, you can’t include that $600 as deductible student loan interest.

Whether your student loan is in good standing or default at the end of the year, if you want to deduct the interest you paid, you have to meet the other eligibility requirements. The student loan must have been used only for education expenses and cannot be from a related person or your employer. In addition, you must be legally obligated to make payments on the loan. Also, your modified adjusted gross income can’t exceed the annual limits, which are $75,000 for singles and $150,000 for joint filers as of the 2011 tax year. Finally, the deduction is limited to $2,500, even if you paid more interest than that on your student loans.

If you meet the qualifications, you can the student loan interest actually paid before you defaulted on your taxes even if you don’t itemize your deductions. If you use Form 1040, report the deduction on line 33. If you use Form 1040A, report the deduction on line 18. If you try to use Form 1040EZ, you won’t be able to claim the deduction.