Are Personal Loans Tax Deductible? Everything You Need to Know
Did you know that some types of loans let you deduct the interest costs from your taxes, like mortgage interest? If you’re paying off a loan, you might be wondering “Are personal loans tax deductible?” or, more specifically, if interest from a personal loan is tax deductible.
This article can help you better understand how personal loans work and if interest could be deducted. However, it’s important to understand that this isn’t tax advice, just information.
Your best bet is to consult a tax professional for answers to your specific questions. In the meantime, this guide can help you come up with what you might need to ask once you visit that tax professional.
What Counts as a Personal Loan?
How does it work? You borrow money from a creditor-such as a bank, credit union, or online lender-and agree to loan terms to pay it back. Your loan terms include the loan amount borrowed, interest rates, loan fees, and repayment schedule.
Following the loan, your repayment schedule details your repayment dates and amount. You repay a personal loan in monthly payments, called installments. These payments are often fixed, unlike credit card payments, and include interest.
Personal loans are almost always unsecured loans. This means you don’t have to put down collateral to get the loan funds. Secured loans have collateral that the lender can repossess if the borrower can’t make their payments.
For example, a car loan is a secured loan. The lender can take possession of the car if the borrower can no longer make payments.
Since most personal loans are unsecured, you can use the money for almost anything. A few reasons you might want to take out a personal loan include:
- Medical bills
- Unexpected car repair or maintenance
- Wedding costs
- Debt consolidation
- Home improvements or renovations
- Small business expenses or starting a small business
Does a Personal Loan Count as Income?
When you take out a personal loan, you are essentially promising to pay your loan lender back. The money is only yours temporarily, and you’ll eventually pay the full amount-plus interest and fees-back to your lender. This means the loan funds are not considered income, unlike paychecks or bonuses that don’t have to be paid back.
Does a personal loan count as income if it’s forgiven?
You should note that if your loan is forgiven or you have a cancellation of debt, it does become taxable income. Any loan amount that’s forgiven by your lender is considered taxable income.
Can a personal loan be used to show proof of income?
Some life situations require you to show proof of income or that you have a certain amount of cash in your bank account. When renting an apartment, for example, most landlords will ask for proof of income. This helps them determine if you are bringing in enough money to cover your rent each month.
While most personal loans simply deposit the loan funds as cash into your bank account, they don’t usually count as income. You won’t be able to use your loan as proof of income for most applications, such as a new loan or rental application.
After applying for a new loan, for example, your lender will see on your credit report that the income in your bank account came from an existing loan.
Are Personal Loans Tax Deductible?
No, in most cases a personal loan is not tax deductible. There are two main reasons personal loan debt can’t be deducted from your taxes:
- Personal loans aren’t income. Remember that proceeds from a personal loan aren’t taxable income. Since you’re not paying taxes on the money you borrow, there’s nothing to deduct.
- Personal expenses aren’t deductible. With very few exceptions, personal expenses aren’t deducted from your taxes. Most personal loans are used for personal expenses, such as covering car repairs or buying new furniture.
Is the Interest on a Personal Loan Tax Deductible?
Just like deducting the amount of a personal loan, you usually can’t deduct the cost of interest. However, in some specific situations, the interest on a personal loan is tax deductible. You may be able to deduct your personal loan’s interest if you use it for these purposes:
Covering Business Expenses
You don’t have to get a business-specific loan to cover business expenses. Most lenders let you use a personal loan for your small business needs.
Many small business owners find it easier to use a personal loan for business expenses than trying to qualify for a business loan. Personal loans tend to be offered in smaller amounts that are ideal for a startup or someone who’s self-employed.
When you use a personal loan for your business expenses, you’re no longer making personal purchases. That means the interest you pay on your loan is technically a business expense, not a personal one. You might be able to subtract interest costs from your business’ taxable income.
What counts as a legitimate business expense? Anything that helps you run your business and is not for personal use.
Qualified Higher Education Expenses
If you use all of the funds from a personal loan for qualified higher-education expenses, it may be counted as a form of student loan by the IRS.
Talk to the Pros
The information above can help you get a better idea of whether or not personal loans are tax deductible. However, tax questions are best left to tax professionals.
A CPA or other qualified tax professional will have the training to consider all of your unique tax implications. Many tax advisors offer an audit guarantee if they make a mistake and there’s https://rksloans.com/installment-loans-nh/ a problem with your tax return.
If you still have questions about maximizing your deductions or using a personal loan for tax deductions, speak with a trusted tax professional to get the answers you need.