Is the Interest I Paid on a Personal Loan Deductible?

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These days, there's a loan for almost every type of situation. If you're buying a home, then a mortgage loan can meet your needs, while vehicle purchasers often take out auto loans to help them buy a new car. Home equity loans can help you finance big renovation projects, and if push comes to shove, a controversial payday loan could help you out of a sticky situation. For those whose needs fall outside these categories, a personal loan could be the optimum choice. But unlike some other loans, they do not lend themselves to tax deductions.

Tips

  • Sadly, the interest you pay on a personal loan is not tax deductible.

What Is a Personal Loan?

While you can get a secured personal loan, most personal loans are unsecured, which means the loan is not backed by collateral. You will not have to put up your home or your car, as you would with a mortgage or an auto loan. Lenders will look at your credit report to determine whether you are eligible for a personal loan, for what amount and at what interest rate. Improving your credit score gives you the best chance of qualifying for a better rate.

Because the loan is unsecured, it is more risky for the lender. If you miss a payment, the lender cannot seize and sell your car or home to get the money back as it could with a secured loan. It can only take you to court and sue you, and then call in debt collectors to collect the money you owe. For that reason, interest rates tend to be much higher with a personal loan than they are with a secured loan.

The loan itself is a fixed-term loan, usually lasting two to five years. You'll receive a lump sum for the loan amount and you'll pay the money back, with interest, in fixed monthly installments over the loan period. Unlike with auto loans and mortgages, you can use the money for almost any purpose, from consolidating high-interest debt to financing a wedding.

Are Personal Loans Considered Taxable Income?

For the most part, a personal loan is not considered to be taxable income. When you receive a check for, say, $5,000, you do not include it in your tax return and you do not pay taxes on this amount.

The only exception is when a lender cancels the loan. Known as loan forgiveness, this happens when the lender decides not to collect the remaining principal or interest from you. Now, the loan becomes a cash sum given to you by the lender. You have to report this amount to the Internal Revenue Service as part of your taxable income. There are some exceptions for bankruptcy, which are a little complicated. Be sure to speak with a bankruptcy adviser if you're thinking about filing for Chapter 7, 11 or 13.

Is Personal Loan Interest Tax Deductible?

The general rule is no, you cannot deduct the payments you make on a personal loan. Just as the loan advance is not considered taxable income, the repayments you make are not considered tax deductible. It doesn't matter whether you are repaying the principal or the interest – you cannot claim a deduction on your taxes for any aspect of a personal loan.

Are Any Loans Tax Deductible?

Interest payments are deductible on other types of loans. Tax-deductible loans typically fall into four categories:

Student loans

Take out a student loan from a qualified lender, and you can deduct up to $2,500 per year. It's only the interest that's deductible, not the entire payment. Private loans from family and friends are not deductible. To qualify for the student loan interest deduction, your modified adjusted gross income must be less than $80,000 ($165,000 for couples filing jointly) in 2019. This amount gets adjusted every year. Use the IRS online student loan assistance tool to see if you can deduct the interest paid on a student loan.

Mortgages

You can deduct interest on your mortgage if:

  • You file an IRS form 1040 and itemize your deductions;
  • The mortgage is secured against your home, i.e., it is not a personal loan.

Starting 2018, married couples filing jointly may deduct interest on the first $750,000 of their mortgage loan, down from $1 million in 2017. For taxpayers who use married filing separate status, the limit is $375,000.

Home improvement loans

Is a personal loan for home improvement tax deductible? The answer again is no. There are two types of home improvement loans – home equity loans or lines of credit, and personal loans. Home equity loans are tax deductible if they meet certain criteria. Personal loans are not.

A home equity loan or HELOC is only deductible if the funds go toward buying, building or renovating your home. Renovation means capital improvements to your home – things that go beyond simple repair. Basically, anything you do that improves the structure of the building, adapts the home to a new use or prolongs the life of your home typically will qualify as an improvement. For example, you can deduct the interest on a home equity loan used to install a new roof. Patching up a leaking chimney stack or skylights will not qualify.

Home equity loans are also tax deductible when you buy a home. Some home buyers take out additional money to make renovations to a home they're purchasing. This money essentially is built into the mortgage and you get mortgage interest deduction the same way.

Business loans

Running a small business isn't cheap, but one of the perks is the business loan interest tax deduction. This is where the IRS lets you write off the annual interest you pay on loans that you use for business purposes, like purchasing equipment or renting an office. The deduction reduces your taxable income and therefore the amount you owe in taxes.

If you have a loan that covers both business and personal expenses, then you can only deduct the percentage of the loan used to fund your business. As with all things business-related, there are exceptions and limitations. Be sure to check with your CPA before filing.

Is It Worth Taking Out a Personal Loan?

Though a personal loan will not give you a tax deduction, you won't need assets like a home or vehicle to get a loan. Plus, your assets are not in jeopardy if you have a hard time making your repayments.

Interest rates tend to be higher than they are for secured loans, but lower than credit cards for borrowers with good credit. If a personal loan has a lower rate than your existing credit card debt, for instance, then it makes sense to pay off your credit card balance and make the lower personal loan repayments instead.

As always, shop around before you make a decision. The quickest and easiest way to get a personal loan is to speak to the bank you're already using and make a loan application. But that might not be the cheapest option. Check out an online comparison site to make sure you're going with the right lender on the most flexible terms.

References

About the Author

Jayne Thompson earned an LLB in Law and Business Administration from the University of Birmingham and an LLM in International Law from the University of East London. She practiced in various “big law” firms before launching a career as a commercial writer. Her work has appeared on numerous financial blogs including Wealth Soup and Synchrony. Find her at www.whiterosecopywriting.com.