Are personal loans tax deductible? The short answer is yes and no.
While the interest you typically pay on a personal loan is not tax-deductible, the way you use the loan could potentially qualify you for a tax deduction if you meet the specific eligibility requirements.
Understanding the tax limitations could help you save money when filing your annual return if you have a personal loan or are considering one soon.
Read on to learn more about all the most commonly asked questions regarding personal loans and tax deductions.
Are Personal Loans Tax Deductible?
In most situations, personal loans are not tax deductible. However, there are exceptions that you should be aware of.
You could qualify for a tax deduction if you need a personal loan for business, educational, or tax investments.
If you don’t need a personal loan for any of the above reasons, getting a personal loan will not impact your taxes.
Getting a tax deduction on a personal loan is an exception, not the rule. Here’s why personal loans don’t affect your taxes:
Personal loans don’t count as income.
When you get a personal loan, the total loan amount does not contribute to your taxable income, meaning that when it comes time to file your taxes, you don’t need to add the balance of your loans to your total income figure or pay taxes towards that amount.
Personal loans are for personal use.
Unfortunately, you cannot deduct personal expenses to save money on taxes. As a result, when you get a personal loan, it’s most commonly for personal reasons and does not qualify for tax deductions.
Some types of loans are allowed, but only the interest is tax deductible
Even with qualified exceptions, you cannot deduct the principal amount from your taxes; You’re only entitled to deduct the interest. For example, let’s say you took out a $2,000 personal loan at 14.9% APR for two years.
Are Personal Loans Considered Taxable Income?
Unlike wages or money you earn from investments, personal loans are not considered income. With a personal loan, you borrow money with the expectation of repaying the balance in full. Therefore, the money you receive from a personal loan is not considered “income” and cannot be taxed as such.
Can Personal Loan Interest Be Deducted from Taxes?
The answer is yes. But it ultimately depends on the circumstances. You are allowed to deduct personal loan interest from your taxes under the following circumstances:
A Personal Loan for Business Expenses
If you’re getting a personal loan to cover business expenses, the interest accrued on your loan can be deducted from your taxes. You don’t need a large business to qualify, and you can deduct your interest costs from your taxes even if you’re a freelancer or working for a gig platform like Uber or Lyft.
Suppose you’re using a personal loan for both business and personal expenses. In that case, you are only allowed to deduct the interest expenses from the portion of the loan you used for those business expenses.
A Personal Loan for Higher Education Expenses
Getting a student loan to pay for higher education is probably the best option for you; however, what happens if you took out a personal loan to refinance your student loan or pay for things like tuition, fees, and other required activity fees? If you took out a personal loan to cover qualified education expenses, such as the ones mentioned above, your loan would count as a student loan. As a result, any interest you pay on the personal loan can be deducted from your taxes.
To qualify for education-related deductions, you cannot be married. The loan must be for you, your spouse, or a dependent while they are enrolled to study at a higher educational establishment.
A Personal Loan for Taxable Investments
If you decide to use a portion of your loan to invest in taxable investments, such as stocks and bonds, you may be allowed to deduct your loan interest amount from your taxes.
You aren’t allowed to deduct interest from tax-advantaged investments such as municipal bonds, partnerships, UITs, Annuities, IRAs, and qualified retirement plans like 401(k)s.
The main downside of this strategy is that you are only allowed to deduct interest to offset investment income for the year.
Examples of loans that are tax-deductible
Mortgages
After the Tax Cuts and Jobs Act of 2017 implemented new rules for deducting mortgage interest payments.
A lower limit was introduced, and now you can only deduct interest on up to $375,000 worth of mortgage debt, and that number doubles if you’re married or file jointly.
If you took out a mortgage before Dec 16, 2016, you could qualify for up to $1,000,000 as a married couple and $500,000 individually.
Another caveat is that you can only deduct mortgage loan interest from your taxes if you use the money to buy, build, or improve your home.
Second Mortgages
If you took out a Home Equity Loan (HEL) or Home Equity Line of Credit (HELOC), the interest payments you make towards those loans qualify for tax deductions.
A key point to remember is that the mortgage value limit of $375,000 as an individual, or $750,000 as a married couple, is calculated by combining the balance of your first and second mortgages.
A caveat is that you must use the loan proceeds to improve the value or extend the home’s life to qualify. If you want to make cosmetic changes to your property, the interest you pay may not meet the requirements for tax deductions.
Business Loans
One of the benefits of running a business is that you are allowed to deduct the interest you pay on a business loan, as long as the loan proceeds are used for genuine business purposes. To qualify for the tax deduction, you must meet the following requirements:
- You must be liable for the debt
- You have the intention of repaying your debt
- You have a real debtor-creditor relationship. I.e., the relationship wasn’t fabricated to qualify for tax deductions.
Student Loans
As a student, you can deduct up to $2,500 in interest payments each year if you take out a student loan to cover qualified higher education expenses. The following expenses qualify for deductions:
- Tuition fees
- Additional school fees
- Accommodation
- Books & Textbooks
- Necessary expenses
How do canceled personal loans affect your taxes?
It ultimately depends on if you’ve received the money or not.
Your tax is unaffected if you applied for a personal loan but canceled it before receiving the funds.
However, If you took out a personal loan and defaulted on your payments, you could potentially owe money to the taxman.
Let’s say, for example; you had a $1,000 personal loan. You defaulted on your payments eight months in, and you have a remaining balance of $200. You can’t afford to repay, so your lender decides to forgive the loan.
Depending on your lender and the severity of the missed payments, your lender might issue you a cancellation of debt and send you a 1099 – C form that you must submit to the IRS with your return.
In this example, your lender forgave $200 of your loan. Therefore, your taxable income now increases by $200. That’s because you received $1,000 but only repaid $800.
The Takeaway
Are personal loans tax deductible? The answer is yes. A personal loan could impact your taxes, depending on your situation and how you use the loan proceeds.
If you need a personal loan, you should try Stately Credit’s payroll deduction loan service! Get an affordable personal loan to help you consolidate existing debt or confidently cover emergency expenses.
