Do You Pay Taxes On Personal Loans?
Miranda Crace5-Minute Read
UPDATED: June 01, 2023
If you’ve recently taken out a loan or you’re considering it, what tax implications come with that? The short answer is “not many,” since loans aren’t seen as taxable income except in rare situations. Also, in some cases, you can deduct the interest paid on a loan.
Let’s discuss personal loan tax implications you should keep in mind, such as when a loan is considered taxable income and when the interest you pay may be tax-deductible.
Is A Personal Loan Taxable Income?
Most types of loans aren’t seen as income, for the simple reason that they must be repaid. The IRS classifies income as money you earn from a job or through investments to keep for your own use. Since you don’t earn anything from a loan you take out – primarily because you have to pay it all back – the IRS doesn’t consider a loan as income when you’re filing your taxes.
When Are Personal Loans Taxable?
However, in a situation where personal loan debt is canceled or forgiven, a personal loan can be treated as income. More on this next.
Cancellation Of Debt (COD)
When a borrower defaults on a loan, they can sometimes work out a deal where a portion of their debt can be canceled or forgiven. When a lender or creditor issues a Cancellation of Debt (COD), the borrower is no longer responsible for the remaining loan amount. However, because that balance isn’t being repaid anymore, it becomes taxable income.
Along with the COD, a lender may send a 1099-C tax form for the borrower to report their canceled debt and the amount unpaid. When they submit their tax returns, the borrower will owe income taxes on that remaining balance.
Let’s say you borrow a $15,000 personal loan and pay back $10,000 over time. Now let’s suppose you can’t pay the remaining principal and default on the loan. If your lender agrees to cancel the remaining $5,000, you’ll have to report that number on your form 1099-C as income since you’re no longer going to pay it back. You’ll then owe taxes on that $5,000 forgiven debt.
Can A Personal Loan Be A Tax Deduction?
Loans themselves aren’t tax-deductible, but the interest on them can be. Like auto loans and credit cards, personal loans don’t generally qualify for tax-deductible interest payments, because a personal loan is typically used for personal reasons – and personal expenses are rarely deductible.
But, again, you’ll find exceptions to this rule, where interest on a personal loan can be tax-deductible.
When Is Personal Loan Interest Tax-Deductible?
What you use a personal loan for can affect whether your interest is tax-deductible. Uses like home improvements or debt consolidation are considered personal, and interest wouldn’t be deductible.
However, as noted above, certain instances can allow you to deduct interest paid from your personal loan. For example:
- Business expenses: If you use a personal loan to finance your business, you can deduct business-related costs from your interest payments. These can include travel, equipment, office space and maintenance for a company vehicle. If you keep itemized records of how you spent the money, you should be able to deduct that paid interest. Make sure your lender allows this type of use for a personal loan.
- Taxable investments: If you borrow money for investments like purchasing stocks, you can potentially deduct up to the amount of the investment income you earn for the year. Again, you’ll need to keep records that prove you used the money for investing.
- Education expenses: A personal loan to pay for qualified educational expenses can be eligible for tax-deductible interest payments. The same is true for the refinance of a student loan with a personal loan. Eligible student expenses can include tuition, textbooks, lodging and more. If you can prove all of the money went to these expenses, you can possibly deduct $2,000 or more in annual interest payments.
On What Loans Is Interest Tax-Deductible?
While personal loans normally don’t qualify for tax-deductible interest, the following loans generally meet the criteria:
- Mortgages: Borrowers can deduct interest on a mortgage when they use the funds to buy, construct or renovate a home. Additionally, if they purchased mortgage points to lower their interest rate, those payments are also deductible.
- Home equity loans: Interest payments on a home equity loan or home equity line of credit (HELOC) can be deductible if the funds are used for qualifying home improvements that add value to the property.
- Student loans: Higher education expenses can qualify for tax deductions on interest paid, as discussed earlier. Unlike with personal loans, you’re not required to itemize how you spend your funds to take the deduction. However, you’ll be ineligible for the deduction if anyone can claim you or your spouse as a dependent, or if you use the “married filing separately”
- Business loans: Similar to using a personal loan for business expenses, interest on business loans can be deducted if the funds are used for business purposes, even if you’re self-employed. Family loans for business don’t qualify for deductions, because they aren’t considered legitimate borrower/lender relationships.
FAQs About Personal Loans And Taxes
Here’s what other people are asking about personal loan tax implications.
How do personal loans affect taxes?
Personal loans generally won’t affect how you file your tax returns, because the IRS doesn’t consider loans as taxable income. The only way a personal loan will affect your taxes is if your lender cancels or forgives the loan.
Are there any tax benefits to getting a personal loan?
Other than the possibility of deducting interest for certain expenses, personal loans don’t offer any specific tax benefits. However, they have the potential to affect your credit score in positive ways.
Can I use a personal loan against the income tax on my tax return?
You can pay your taxes with a personal loan if you get a big tax bill you can’t afford. Be aware that most lenders won’t offer loan amounts lower than $1,000.
Are payments for personal loans tax-deductible?
As with auto loans and credit card debt, personal loan payments aren’t tax-deductible. Loan interest may be deductible if the funds are used for business or education expenses, or investments.
You’ll want to be prepared come tax season, with all of your forms in order and your income ready to report. Knowing ahead of time whether your loan will be considered taxable income, or if you can deduct any interest payments, can help ensure you have a smooth tax year and avoid any trouble with the IRS. If you do have tax-deductible interest, be sure you’ve been properly itemizing your spending to avoid any post-filing surprises.
If you’re looking to secure a personal loan, you can get started today with a prequalification from Rocket Loans℠.
Rocket Loans does not provide legal or tax advice. The information herein is general in nature and should not be considered legal or tax advice. Consult an attorney or tax professional regarding your specific situation.
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