There are plenty of reasons to take out a personal loan, many of which are totally financially savvy. For instance, you might be thinking about consolidating high-interest debts like credit card balances.
Or you might plan to borrow in order to repair the roof or remodel the kitchen to help increase your home value.
Maybe you’re considering taking out an unsecured personal loan to pay for an unexpected medical bill.
Whatever the case, personal loans can be a useful tool to help you cover expenses and stabilize your finances. Plus, they may be easier to qualify for than other types of loans and come with less red tape.
But as in all things finance, Uncle Sam wants his cut, too. So, as you consider your borrowing options, you might wonder about how taxes work on unsecured personal loans.
For instance, you may question if a personal loan can be taxed as income and whether you can get a personal loan interest tax deduction.
If you are trying to decide between several types of financing, reviewing the potential tax implications of each borrowing option can help you figure out a financing strategy that fits your situation.
In this article, we’ll cover things you’ll likely want to know about when it comes to tax on personal loans, including whether personal loans qualify as income, and whether the interest on them is tax-deductible.
Plus, we’ll cover some scenarios that can come with tax benefits that might apply to you and your loan. This way you’ll be armed with helpful knowledge useful when making the right borrowing decisions for you.
It is, however, important to note that we’re not tax experts. For any tax-related questions or advice, you’ll want to consult a tax accountant — and not a blog post like this one.
Related: A guide to understanding your taxes
Are Personal Loans Considered Taxable Income?
When you take out a personal loan, your lender agrees to loan you a particular amount, and you agree to pay that loan back over a set period of time with interest.
Which is actually good news on the tax front: Even though it seems 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 would.
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 can be a rare occurrence and typically occurs 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, and it can carry tax liabilities since you’re receiving the remainder of the loan without the caveat that you’ll be paying it back.
For instance, let’s say you’ve taken out a $10,000 personal loan and have paid back $8,500 of it when the debt is forgiven or cancelled. The remaining $1,500 that you’d no longer have to pay back can be taxed as income during the year it is cancelled.
Typically, your lender will send you a tax form (a 1099-C) stating the amount cancelled, which you must subsequently report to the IRS on your tax return. Again, this is a very, very rare circumstance, so it’s nothing to count on.
Bottom line: In most situations, personal loans are not taxable as income — but if your loan is cancelled or forgiven, the remainder of the loan amount that you’ve yet to repay can be taxed the same way regular income is.
Is Personal Loan Interest Tax Deductible?
The IRS regulates which types of loans come with tax deductions. While there are some types of loans that have tax-deductible interest, unfortunately, personal loans don’t fit into that category.
The interest you pay on personal loans is 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.
Types of Loans with Tax Deductible Interest
Although personal loan interest isn’t tax deductible, there are many other types of loans that do carry special tax benefits and interest deductions. For instance, student loan interest and mortgage and property loan interest can be deductible up to certain amounts, although there are some restrictions.
1. 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.
However, this deduction is gradually phased out as your income increases, and it is not available if you or your spouse can be claimed as a dependent on someone else’s tax return.
2. Property Loan Interest
In the majority of cases, you can deduct every cent of interest you pay on your home mortgage. The loan must be secured (that is, your home must be offered as collateral on the loan; this deduction will not work if you use an unsecured personal loan to cover some or all of the cost of your housing).
As of 2018, you can deduct the interest on up to $750,000 of a qualified home loan if married and filing jointly, or up to $375,000 of qualified debt for single filers. (These limits were lowered from $1 million under the Tax Cuts and Jobs Act of 2017, but if you signed your mortgage before December 16, 2017, you’re grandfathered into the previous limit.)
3. Business Loan Interest
Some business expenses are tax deductible, and that includes the interest you pay on loans taken out for business-related purposes. However, you can also deduct business expenses you pay for using an unsecured personal loan, which we’ll dive into a little bit more deeply in the next section.
How Can Personal Loans Help You Get Your Money Right?
Although staying debt-free is standard financial advice, sometimes taking out a personal loan can be a smart money move, especially if you’re already dealing with high-interest forms of debt, such as consumer credit cards.
Debt consolidation, a financial tactic, which involves taking out one large loan to cover multiple smaller debts, may reduce your credit utilization ratio and potentially help you save money on interest, not to mention make your bill-paying schedule a whole lot simpler.
For example, maybe you owe $8,000 on one personal credit card and $4,500 on another credit card, both with high (and different) interest rates. With multiple bills coming due at different times of the month, chances are you’re only paying the minimum required amount on each of them, which means you’re paying them off slowly and paying a lot of interest.
However, if you were able to qualify for and take out a $12,500 personal loan at lower interest rate, you’d only have to worry about one payment date, and you might even save money on the sky-high credit card interest rates, which could simplify both your life and your finances.
Personal loans (home improvement loans) can also help you get started on major home renovations, which may increase the value of your house and help you earn back your investment in the form of equity.
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.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
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