See the results of our 2022 Personal Finance Study!
Are Personal Loans Tax Deductible?
Is personal loan interest tax deductible? This is a common question among borrowers. The answer is generally no, but there are exceptions to the rules when it comes to personal loan interest tax deductions.
Is Personal Loan Interest Tax Deductible?
The interest you pay on car loans, credit cards, or unsecured personal loans is not tax deductible but there may be exceptions if you use the loans for:
- Business purposes
- Higher education expenses
- Taxable investments
Using a Personal Loan for Business Expenses
There are many expenses associated with starting a new business, even if it's a side hustle or part-time gig. You may need a new computer, office space, equipment, and supplies to get started. Many new business owners turn to loans to fund their startup costs. While you can take out a business loan specifically for this purpose, you can also borrow money with an unsecured personal loan. You can use a personal loan for business purposes and the interest associated with the portion you use for your business expenses are tax deductible.
The good news is your business doesn't have to be considered large or need multiple employees to receive the benefit of a tax deduction. A business loan or personal loan can be used towards expenses associated with small operations, including side hustles, freelance, or consulting work.
Personal Loans for Education Expenses
When people need money for higher education, they usually think of federal and private student loans first and not personal loans. Federal student loans have multiple advantages, including low interest rates, longer repayment terms, and no credit check is required. Private student loans can also be used to help cover education costs, but these types of loans do not have the advantages of a federal student loan.
What borrowers may not realize is they may be able to use a personal loan for qualified education expenses, such as college tuition or activity fees, or refinancing a student loan, and the interest payments could qualify as a student loan interest deduction. However, before you go down the path of using a personal loan for educational expenses, check with the lender to confirm if this is allowed, since some lenders prohibit using the funds for higher education costs.
There are income limitations and other rules set by the IRS for claiming the interest. For example, you can't claim it if you are married and file separately from your spouse.
Personal Loans for Taxable Investments
One more exception to the personal loan interest deduction question is for taxable investments. You may be able to deduct the interest on a personal loan if you use the money for taxable investments, such as certain stocks, bonds, mutual funds, or ETFs.
Like the other categories, there are multiple stipulations in place when using personal loans for taxable investments. The interest may be tax deductible but you'll have to itemize your deductions for the investment interest, and it only applies if you make enough income from the investments in the same year. Most borrowers won't be able to take advantage of this exception for personal loan interest deduction, but it is worth noting.
Is a Personal Loan Considered Taxable Income?
In most cases you can't deduct personal loan interest on your taxes and that may lead you to wonder if a personal loan is considered taxable income. The answer is generally no, since you're repaying the money. And yes, there are exceptions to this too. If the lender cancels or forgives your debt, or a portion of your debt, then the amount forgiven will be reported as taxable income.
Why Understanding a Tax Deduction on a Personal Loan Matters
There are numerous advantages to an unsecured personal loan. You can use them for a variety of purposes, from providing much-needed repairs to your home to covering an unexpected medical bill. The funding is typically fast and you receive one lump sum to distribute as you need. Once your payments begin, you have one fixed monthly payment for a specified time period. However, the lender charges interest, so the longer you take to repay your loan the more you'll pay in interest over time.
If you need a personal loan, the first question to ask yourself is how you will use the funds. There are loans where the interest is tax deductible, including mortgages, student loans, and business loans. If your needs for an unsecured personal loan fall into one of these three categories, then it may make more financial sense to explore borrowing with one of these loans versus a personal loan, so you can reap the benefit of the tax deduction.
Keep in mind you shouldn't rely on a tax break to be able to afford the repayment of a loan. If you evaluate your monthly payment amount for a personal loan (or other type of loan) and it puts too much strain on your budget, then you can't afford the loan amount and should consider an alternative if possible. There may be other affordable borrowing options available, such as a low-interest credit card or personal line of credit. As with any borrowing decision, compare all available options to ensure you're getting the best interest rate and repayment terms for your personal financial situation at a rate you can afford.