Interest payments on personal loans are not tax-deductible. However, there are exceptions. For example, interest paid on personal loans used to pay for business expenses or qualified educational costs can be deducted from your annual taxes, which will reduce your taxable income.
Personal loans are a financial tool you may want to have in your tool belt. They can be an excellent tool to pay down credit card debt or make a major lifestyle change. SuperMoney’s in-depth guide on best personal loans is a great place to decide what personal loan is right for you! However, the tax implications of personal loans are confusing and dependent on what expenses you use the loan for. Below, we break down how personal loans may affect your tax returns.
Can a personal loan be tax deductible?
As a general rule, interest payments on personal loans are not tax-deductible as with mortgages and student loans. For example, if you borrow money to purchase a car or cover other personal expenses, the interest payment will not reduce your taxes because it is a living expense and not income. However, you may be able to take a tax deduction if you meet certain eligibility requirements and use the loan for specific purposes.
How do I get a tax benefit on a personal loan?
You may be able to take a tax deduction if you use a portion of your personal loan for business expenses, qualified higher education expenses, or taxable investments. However, you must meet specific criteria, as explained below.
1. Business Expenses
The interest accrued on loans (whether it is a personal loan or credit card) used for certain business expenses may be tax-deductible. In general terms, the interest on loans can be deducted if the loan is associated with purchases to finance what your company does. For example, office furniture or an office vehicle are eligible business expenses that reduce your business’ income, thereby reducing your tax liability.
To claim the deduction on interest, you must be legally liable for the loan and you must itemize the portion of the interest paid that is attributable to business expenses. For instance, a vehicle you purchased with a personal loan and use 70% of the time for business-related activities only has 70% deductible annual interest.
2. Student Loans
You may be able to claim a student loan interest deduction on the interest paid if you use the student loan exclusively for qualified education expenses or to refinance a preexisting student loan. You may be able to deduct up to $2,500 in interest per year. This is an “adjustment to income,” which means it can be claimed if the taxpayer itemizes their deductions.
However, certain exceptions apply to this deduction. If someone can claim you as a dependent on their tax returns or if you file as “married filing separately,” then you cannot claim the deduction. Furthermore, you must enroll at least half-time in a recognized degree, certificate, or credential program and receive the loan through yourself, your spouse, or a dependent. The deduction is also modified based on your modified adjusted gross income (MAGI). In 2019, the Internal Revenue Service (IRS) stated an individual’s MAGI must be less than $85,000 (under $170,000 for a joint return) to claim the deduction.
You can also claim an education credit for qualified education expenses paid with money from a loan.
3. Taxable Investments
Loans used to purchase taxable investments, like stocks, bonds, and mutual funds, may be eligible for interest deduction. However, tax-advantaged bonds are not eligible. In order to determine if you are eligible for the investment interest deduction, you need to itemize your deductions. You also can only use your deduction to offset investment income for the year. If you don’t have enough investment income, you may be able to carry over the interest expenses to the next year.
Under Section 80C of the Income Tax Act, you can claim an income tax deduction on your personal loan if you use it to purchase, build, or improve a house. The catch is the loan needs to be secured by the taxpayer’s home (main or second home). The interest you pay on mortgages and home equity lines of credit (or loans) can be deductible, but they have to be secured by a home.
Personal loans are unsecured so they don’t qualify. You can work around this requirement if you are buying a rental property or if the property is a business expense.
Learn more about how to save on taxes and remodel your home at the same time!
Remember that to benefit from this deduction, you must itemize your deductions. Also, a recently passed law—the Tax Cuts and Jobs Act of 2017—limits the amount of interest you are able to deduct. An individual can deduct interest up to an amount of $375,000 ($750,000 for jointly filed taxes).
Personal loans and taxes
Personal loans are not considered income, and therefore they are not taxable. However, the lender may forgive or cancel some of your debt, in which case the unpaid portion may affect your taxes. This can occur in various situations, such as if you fall behind on a repayment schedule or if you settle a debt with a creditor for less than you owe.
In these cases, the creditor will send you a Form 1099-C, which you will have to include in your tax return. Oftentimes what you pay in taxes is less than the outstanding balance on the loan, saving you money. Still, it is important to be aware of the tax consequences of a canceled personal loan.
You may qualify for exceptions that allow you to not include forgiven or canceled debt in your taxable income. Some exceptions include if you have more liabilities than assets (known as being insolvent) or if you qualify for certain federal student loan forgiveness programs.
For more information on how personal loans can affect your taxes, read this article.
Personal loans to pay taxes
You can use a personal loan to pay off taxes. It won’t be tax-deductible but it may save you a ton of money in tax penalties and interest. This may be a smart strategy to pay your tax debt on time and avoid trouble with the IRS. You can learn more about this strategy here.
- To receive tax deductions on your personal loans, you must meet stringent requirements. This includes using your personal loan to pay for business or educational expenses.
- You must itemize your deductions to qualify for most personal loan benefits.
- You can use personal loans to pay off your taxes.
- Qualified Education Expenses – IRS
- Publication 936, Home Mortgage Interest Deduction – IRS
- Publication 550, Investment Income and Expenses – IRS
- Best Personal Loans | December 2021 – SuperMoney
- 2021 Personal Loans Industry Study – SuperMoney
- Topic No. 456 Student Loan Interest Deduction – IRS
- How to Qualify for a Personal Loan? – SuperMoney
- Taking a Loan to Pay Taxes? Here’s What You Need to Know – SuperMoney
- Are Home Improvement Loans Tax Deductible? – SuperMoney