Taking out a personal loan can provide funds when you need them for major expenses, debt consolidation, or other financial needs. That said, you may want to consider the implications of personal loan taxes.
While the loan principal itself is not subject to income tax, certain aspects of personal loans do raise potential tax considerations. Unlike home loans or student loans, the interest payments on personal loans are not tax deductible. And, if part or all of a personal loan is forgiven, that canceled debt could be treated as taxable income, and you may need to file a 1099-C tax form.
In this article, we’ll provide an overview of how personal loans may factor into your annual tax filing.
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With a good credit score, you can borrow money quickly with a personal loan. A personal loan may be a good option when you need flexibility in spending money. Most personal loans are unsecured, so you don’t need collateral, such as a house or stock, to borrow money. That said, you should understand the tax implications before taking out a personal loan.
For starters, personal loans do not provide any tax deductions typically. The interest paid on personal loans cannot be written off on personal tax returns, unlike a mortgage or student loan interest.
In some rare cases, if your lender forgives part or all of your outstanding loan balance, then the amount forgiven may count as taxable income. The concept is that forgiven debts remove your obligation to pay back money, functioning as a financial benefit. If you receive any type of loan cancellation or forgiveness for more than $600, you’ll need to fill out and file a 1099-C tax form.
In some cases, interest from investments you purchase with a personal loan may still be tax deductible. For example, you took out a personal loan to invest in a rental property. The rental property expenses, including mortgage interest, may still be tax deductible. However, some exceptions can apply, so it’s recommended that you consult with your tax advisor for the full picture.
Do personal loans count as taxable income?
No, personal loans don’t count as taxable income in most cases. A personal loan isn’t considered income by the IRS because it’s essentially you borrowing your own future income. This means the loan principal itself does not get added to your income and isn’t considered taxable.
Are personal loan interest payments tax deductible?
No, personal loan interest payments are generally not tax deductible. Unlike home mortgages or student loans, you can’t deduct the interest portion of your loan payments on your tax returns.
There are a couple of reasons why personal loan interest isn’t tax deductible. For starters, the IRS classifies personal loans as separate from other required categories for deductible interest. This is because personal loans are seen as voluntarily taken out to fund consumer expenditures rather than socially motivated cases like housing or higher education.
There are also some policy concerns allowing tax deductions on personal loans could promote overspending and heightened borrowing.
While the interest portion of all personal loan payments must be paid out of after-tax income, some exceptions exist.
Tax deductible uses of personal loans
The interest paid on a personal loan could be tax deductible in certain situations.
For instance, you might be able to deduct your interest payments if you spend the money on business expenses or certain investments, such as rental properties. In some situations, you may be able to deduct the interest if you use the cash toward qualified education expenses.
While there are some exceptions to the rule, they need to be limited. It’s best to consult with your tax advisor to learn which tax deductions you may qualify for.
1. Business expenses
Personal loan interest may be tax deductible, in some cases, if used to pay for business expenses. The business expenses will have to be qualifying and you’ll likely need to meet other criteria. There may be other restrictions on this practice so it’s best to consult with your tax advisor to be sure.
2. Education expenses
You may be able to deduct the interest when you use a personal loan for qualified education expenses. Like student loans, qualified expenses may include tuition, books, and school supplies. However, all personal loan proceeds must be used for qualifying educational expenses to qualify for a tax deduction.
There may be other restrictions as well, so it’s recommended that you consult with a tax advisor to determine exactly how to approach this situation.
3. Business investments
Personal loan interest may be tax deductible in some scenarios where investors purchase a rental property. Certain expenses associated with rental properties tend to fall under the tax-deductible umbrella, and if you’re paying them with a personal loan, you may be entitled to certain tax deductions.
To get a better idea of what types of tax deductions you could qualify for if you use a personal loan for an investment property, it’s best to consult with your tax professional.
Keep in mind that you can’t deduct personal loan interest on investments held in tax-advantaged accounts, like an IRA or 401(k).
Non-tax deductible uses of personal loans
When you use the money for personal reasons, the interest you pay on a personal loan isn’t tax deductible. Personal loans are flexible, and you can use them in a variety of ways. Just don’t expect to reap any tax benefits if you’re going to finance the following:
1. Vacations and travel expenses
According to an article from 2017, as many as 74% of Americans have used financing to foot some or all of their travel getaways. However, interest paid on a personal loan for a vacation or travel expenses, such as airfare, hotels, or meals, is not deductible.
2. Debt consolidation
If you use the money to consolidate personal debt, such as private student loans or personal credit cards, interest paid is not deductible. If you are thinking about debt consolidation, you’ll want to try and find a loan with the lowest interest and most favorable terms.
3. Everyday expenses and luxury items
No interest deduction is allowed on your tax return when using a personal loan to pay for everyday expenses and luxury items, such as swimming pools. Like an auto loan, the interest paid on a personal loan isn’t deductible when you buy a car.
Personal loan interest also can’t be deducted if you use the money for home renovations. However, you may be able to deduct interest if you take out a home equity loan. There are some restrictions around that so be sure to talk to your tax advisor.
What are the limits on the amount of personal loan interest that can be deducted?
Even if you qualify for one of the rare exceptions to a personal loan tax deduction, the IRS may limit your personal loan interest deduction. For example, personal loan interest paid toward business expenses could be limited in certain cases. Check the IRS rules for limits on the amount of personal loan interest you can deduct or talk with a tax professional to be sure.
Tips for maximizing personal loan tax benefits
Here are a few tips to help maximize tax benefits when using a personal loan for qualified expenses.
Keep proper documentation
If you plan to use personal loan proceeds to fund expenses for your business, consider putting a business loan agreement in place with your company. Spell out the repayment terms and interest rate. Having a loan agreement in place can be especially helpful if the money from your personal loan pays both business and personal expenses.
In addition, keep copies of business invoices or receipts to show how and where you spent the money if the IRS questions the personal loan interest deduction.
Understand loan terms and interest rates
Ensure you understand the basic terms of your loan agreement, such as your monthly payment, interest rate, and loan terms. If you can’t meet the terms of your loan agreement, anything you can’t repay could be considered taxable income.
If you don’t get a tax break, consider repaying your personal loan as quickly as possible to minimize the interest you pay. Just be sure to check your loan agreement closely for any lender prepayment penalties.
Consider consulting a tax professional
The tax implications associated with personal loans can be complicated. You could have taxable income if your interest rate is too low or you default on the loan. A tax professional can help you navigate the complexities associated with personal loan taxes.
Tax Benefits of Personal Loan Interest
A personal loan can be an easy way to get money when needed. You can pay your bills or take a dream vacation with the extra cash. Unlike other loans, the interest you pay on a personal loan is generally not deductible. Sometimes, a personal loan may lead to tax benefits through interest deductions if you use the money on qualified expenses.
To be sure of how personal loan taxes would apply to your specific situation, it’s recommended to have a talk with your tax professional. In the meantime, you’ll want to ensure you’re getting the best potential offer for your situation.
MoneyLion makes it easy to ensure you can choose your best personal loan offer by compiling multiple personalized offers into a single interface. Learn what you could qualify for and compare offers!
FAQ
What are the tax implications if I use my personal loan for a mix of personal and business expenses?
When a personal loan is used to finance personal and business expenses, you can deduct the proportion of interest expense paid for your business use of the funds.
Can I deduct the principal amount of my personal loan from my taxes?
No, you cannot deduct the principal amount of a personal loan from your tax return.
Is personal loan interest deduction available for both federal and state income taxes?
Every state has its own set of state income tax rules. Even if you qualify for a personal loan interest deduction for federal income taxes, you should verify the rules with the state you file your return in.
