If you borrow money to purchase a Certificate of Deposit, how is the interest treated for tax purposes?

When you borrow money to purchase a Certificate of Deposit (CD), the interest income earned from the CD is considered taxable income. This means you must report it on your tax return and pay taxes on that amount. Generally, the Internal Revenue Service (IRS) classifies interest earned on savings and investment accounts, including CDs, as taxable income in the year it is earned.

On the other hand, the interest you pay on the loan used to purchase the CD typically does not qualify for a tax deduction. The IRS generally allows deductions for certain types of interest, such as mortgage interest or student loan interest, but personal loan interest does not fall into this category. As a result, although you may be paying interest on the borrowed funds, that interest is not tax-deductible.

This understanding clarifies that while the interest earned on the CD is subject to taxation, the interest on the loan is not eligible for deduction, aligning with the correct answer regarding the taxable treatment of both types of interest in this scenario.