If you have a personal loan now or are considering paying off a loan or making a major purchase in the future, it can be helpful to know if there are any potential tax implications when filing your return.
While there isn’t a set personal loan tax, knowing when and how a personal loan might affect your taxes can help ensure you don’t miss out on potential deductions. Read on to find answers to some of the most frequently asked questions about personal loans and your taxes.
Are Personal Loans Tax Deductible?
Interest on personal loans is not tax-deductible. When you take out a loan to buy a car for personal use or to cover other personal expenses, the interest you pay on that loan does not reduce your tax liability. Likewise, interest on credit card balances is generally not tax-deductible.
there are a few exceptions to the rule. If you use the loan proceeds for business expenses, skilled education expenses, or eligible taxable investments, you may be able to deduct the interest from your taxes. If for any of these reasons you do not get the loan, a personal loan will not affect your taxes.
A personal loan can help you save money by consolidating high-interest debt or by providing the funds you need for an emergency or unexpected expense. Although there are exceptions, personal loans generally do not affect your taxes. Here’s why:
- It’s not income. The money you receive from a personal loan isn’t added to your taxable income, and you don’t have to pay taxes on the money you borrow.
- It’s for personal use. Personal loans are often for personal use, and you generally don’t get to deduct personal expenses.
- Even when allowed, interest is deductible. Some types of loans can qualify for a tax deduction. But generally, you can deduct only the interest portion you pay on the loan (and sometimes origination fees in the case of student loans, for example), not the loan amount.
When Is a Personal Loan Tax Deductible?
Depending on how you use the funds, the interest you pay on a personal loan may be tax-deductible in certain circumstances.
For example, if you take out a loan solely to pay for qualified training costs or to refinance a student loan, you can claim the interest deduction for the student loan. Similarly, if you used a personal loan for these purposes, you may also be able to claim an investment interest expense or a business expense allowance. However, some lenders and credit marketplaces (like Lending Club) may not allow you to obtain personal loans for these types of purchases.
Additionally, an unsecured personal loan is not eligible for mortgage-related deductions because the loan is not secured by your home (more on this below). This also applies when you take out the home improvement loan.
Which Loans Are Tax Deductible?
You can’t deduct an unsecured personal loan’s interest on your taxes unless you use the loan’s proceeds for one of the following purposes:
- Business expenses
- Qualified higher education expenses
- Taxable investments
There are many costs associated with starting or running a business and you may need to obtain credit to cover them. The accrued interest on this loan can be tax-deductible depending on the purpose of the funds. You don’t necessarily have to run a large company either; You can also qualify if you have a part-time job as a freelancer or consultant.
The interest related to a loan used to purchase consumables for a product that you make and sell online or, for example, to purchase furniture for a rental property, can be considered a business expense.
You can deduct the expenses from your company’s income, which can reduce your tax liability for the year. If your expenses exceed your company’s income, you could suffer an annual loss that could offset other types of income.
When you use a personal loan for personal and business expenses, you can only deduct the interest associated with the portion of the loan that you use for business expenses.
Qualified Educational Expenses
Most people take out government or private student loans to pay for their college education, and for good reason. Student loans often have specific repayment schedules that are better tailored to the needs of the student when compared to other forms of debt. In addition, most federal student loans do not require a credit check and can qualify for forgiveness and hardship programs.
However, if you use all of the resources of a personal loan to refinance a student loan or to pay for qualified education costs such as tuition, fees, and required activity fees, it can qualify as a qualified student loan. As a result, the interest payments may be eligible for the interest deduction on the student loan, and you may be able to deduct any interest you paid for the year.
The student loan interest deduction is especially valuable as it is an over-the-line deduction (technically more of an adjustment than a deduction). You can also claim it when listing your deductions and it can help you qualify for other tax deductions or credits.
However, there are also requirements and restrictions. For example, you will not be able to claim the deduction if your tax return status is separate marriage and the amount of the deduction may be reduced based on your modified gross adjusted income for the year.
The loan must also apply to you, your spouse, or a dependent, while they are at least half, enrolled in a recognized degree, certificate, or program.
You may also be able to deduct interest on a loan if the money is used to purchase taxable investments, such as certain stocks, bonds, or mutual funds. However, the deduction is not permitted for purchases of tax-privileged investments such as tax-exempt bonds.
If you use the loan for any other purpose or type of investment, you can still take an interest deduction equal to the amount you use for qualifying investments.
You need to list your deductions to account for the investment interest deduction, which means most people will not benefit from it. Additionally, you can only deduct interest to offset investment income for the year.
If you don’t have enough investment income, you can carry over chargeable interest payments to the next year to help offset future investment income.
How Does Canceled Personal Loan Debt Affect Your Taxes?
If a creditor cancels, settles, or waives part of your debt, the part of the loan that you have not repaid can be considered taxable income. This is often the case when you default on payments and negotiate a settlement with the creditor.
The creditor will send you a Form 1099-C, Debt Relief, which shows how much debt has been canceled. You may need to include the canceled debt in your income and tax the amount. There are exceptions, however, and you may be able to exclude the amount from your income if you are insolvent (i.e., your liabilities exceed your assets).