A personal loan gives you access to a lump sum of cash that you can use for virtually any purpose (like consolidating credit card debt, paying for a wedding, or making a large purchase). You then repay the loan, plus interest, in regular installments over time. You might wonder then, is a personal loan considered income? Will you need to pay taxes on it?
Generally, no. Unless the lender forgives some of your debt (say due to financial hardship), personal loans are not considered taxable income, since you repay the money you receive.
Read on to learn more about how a personal loan impacts your taxes, whether you can deduct the interest you pay (and lower your taxes), and how other popular types of loans might impact your tax return at the end of the year.
Table of Contents
Key Points
• Personal loans are generally not considered taxable income, unless the lender forgives some of the debt.
• If a personal loan is forgiven, the canceled amount may be taxed as income.
• Personal loan interest is generally not tax deductible, except in certain cases like using the loan for business purposes.
• Other types of loans, such as student loans and home loans, may have tax-deductible interest.
• Taking out a personal loan does not have a direct impact on your taxes, and it won’t lower your taxes either.
Are Personal Loans Considered Taxable Income?
When you take out a personal loan, your lender agrees to loan you a set amount of money, and you agree to pay that money back with interest over a set period of time. While it may feel like a windfall that you could be taxed on, it isn’t. Since you are agreeing to pay that money back, it does not qualify as income the way wages from a job or income from investments would.
Generally, the only instance when money from a personal loan can be taxed as income is if your lender agrees to forgive the loan. Loan forgiveness is a relatively are occurrence and typically happens under the following circumstances:
• You are renegotiating the terms of a loan you are struggling to repay.
• You’re declaring bankruptcy.
• Your lender decides to stop collecting on the loan.
This is called a cancellation of debt (COD), and it can carry tax liabilities since you’re technically keeping the remainder of the debt, rather than paying it back.
For instance, let’s say you took out a $10,000 personal loan and have paid back $8,500 of it when the debt is forgiven or canceled. The remaining $1,500 that you no longer have to pay back can be taxed as income during the year it is canceled.
Typically, your lender will send you a tax form (a 1099-C) stating the amount canceled that you’ll need to submit with your tax return when you file.
There are a couple of rare exceptions to the COD income rule: If the loan balance is forgiven as a “gift” from a private lender, or if the debt is forgiven in the lender’s will, the amount does not have to be reported as income.
Bottom line: In most situations, personal loans are not taxable as income — but if your loan is canceled or forgiven, the loan amount that you’ve yet to repay can be taxed the same way regular income is.
Is Personal Loan Interest Tax Deductible?
A tax-deductible expense is money a taxpayer can subtract from their overall gross income to reduce their reported income and therefore the taxes they have to pay.
Unlike some other common types of loans, the money you pay on interest for a personal loans is generally not tax deductible. So if you take out a loan and pay a few hundred dollars in interest over the course of your repayment, that’s not a cost that will reduce what you owe in taxes come April.
There are, however, some exceptions to the rule. One is if you are self-employed or own your own business and use some or all of the money for your business. You may then be able to deduct the corresponding amount of interest payments from your business income. You’ll want to be make sure the lender allows you to take out a personal loan for business use (some do, others don’t), and keep records of how you spend the money.
If you used all or a portion of a personal loan for business purposes, it’s wise to talk to an accountant or other tax professional before you claim this on your taxes.
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Types of Loans with Tax Deductible Interest
Although personal loan interest typically isn’t tax deductible, there are many other types of loans that do allow interest deductions. Here’s a closer look.
Student Loan Interest
You may deduct up to $2,500 of interest on qualified student loans or the full amount you paid during the tax year — whichever is the lesser. You can take this deduction even if you don’t itemize. However, the student loan tax deduction is gradually phased based on your modified adjusted gross income, and is not available if you use the “married filing separately” status or if someone can claim you or your spouse as a dependent.
Home Loan Interest
The interest you pay on a qualified mortgage or home equity loan is deductible on your federal tax return, but only if you itemize your deductions and follow IRS guidelines. For many taxpayers, the standard deduction beats itemizing, even after deducting mortgage interest.
In order to deduct your mortgage or home equity loan interest, the loan must use your home as collateral (a personal loan you’ve used to improve your home, for example, doesn’t qualify as mortgage interest). In addition, the home must be your home or second home, and the loan proceeds must be used to buy, build, or substantially improve your home.
Business Loan Interest
If you are self-employed or own a business, you may be able to deduct the interest you pay on a business loan you use to cover business-related expenses.
To qualify, you must be liable for the debt and must have a true debtor-creditor relationship with the lender (i.e., the lender cannot be a friend or family member). You also need to have spend the funds — if the proceeds from your business loan are just sitting in your business bank account, the interest isn’t tax deductible.
The Takeaway
Generally, getting a personal loan does not have any impact on your taxes. Even though you’re getting a cash infusion to your bank account and you can spend that money virtually any way you want, a personal loan is a form of debt, not income. Thus, it won’t have increase you tax bill at the end of the year.
Taking out a personal loan generally won’t lower your taxes, either, since interest you pay on a personal loan isn’t considered tax deductible.
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Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
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