Personal Loan Tax Deduction – Like any other form of credit, personal loans must be repaid with interest and the longer the loan term, the more interest you will pay over the life of the loan.
While the Internal Revenue Service typically allows individuals to claim a tax deduction for interest paid on student loan debt, you may want to ask whether you can also claim a tax deduction for interest paid on a personal loan.
What Is Personal Loan Tax Deduction?
While personal loans are tax-free, other types of loans are. Interest paid on mortgages, student and business loans can often be deducted from your annual taxes, effectively reducing your taxable income for the year.
However, certain criteria must be met to receive the above deductions. For example, mortgage interest is only deductible if the loan was taken out to finance the purchase of a primary residence.
You can get a mortgage interest tax credit, which directly reduces the amount of tax you have to pay, not your taxable income, for mortgage interest if you were issued a mortgage loan certificate through the state’s low-income housing program.
You don’t need a tax credit to get a personal loan. If you’re interested in taking out a personal loan but aren’t sure how much you’ll be able to repay, you should consider using a personal loan calculator to determine what you can afford each month.
ALSO CHECK: HOW TO CALCULATE TAX REVENUE
How Do Personal Loans Work?
A personal loan is a liability, meaning it’s something you owe, as opposed to taxable income you receive. Thus, personal loans are tax-free and interest-free.
Depending on how you use a personal loan, it could be a taxable event. An example is using a personal loan for business expenses.
Any interest paid on the loan may be tax deductible for the business. The money should be used solely for business expenses and that it is best to consult a tax advisor to understand the implications.
ALSO CHECK: Are Political Donations Tax Deductible? What You Should Know!!!
Personal Loans Example
Using a personal loan for business expenses can be another gray area, as some lenders don’t allow borrowers to use the funds for business-related expenses — however, business loan interest is tax-free.
If you need to borrow more than $100,000 for business expenses, you’re better off applying for a small business loan, as personal loan lenders usually don’t offer more than $100,000.
The best way to find out what you can and can’t use a personal loan for is to check the terms and conditions before you apply and accept it.
Personal loans can generally be used to pay for anything from medical bills and home repairs to wedding and funeral expenses, or even for a vacation or debt consolidation. As with any financial product, be sure to read the terms and conditions before agreeing to proceed.
ALSO CHECK: Service Revenue: Definition And Types
Are Personal Loans Considered Taxable Income?
If personal loans are counted as part of your taxable income, are you really saving anything by deducting the interest involved?
This may be reasonable, except that personal loans are not considered taxable income. Taxable income is defined as the money you earn after deductions from your adjusted gross income (AGI), primarily through work or investments.
Since personal loans are funds obtained with the intention of repayment, they do not increase the taxable income of the borrower.
ALSO CHECK: Are HOA Fees Tax Deductible? All You Need To Know
Is Interest On Student Loans Tax Deductible?
Interest on student loans (along with loan origination fees and any capitalized interest) is tax-free if the borrower’s income is below a certain level.
The Internal Revenue Service (IRS) states that an individual’s modified adjusted gross income (MAGI) must be less than $85,000 (or $170,000 if filing a joint return) for the 2019 tax year.3
A deduction can reduce the amount of income subject to federal income tax by up to $2,500.3 This amount is classified as an income adjustment and can be claimed even if the taxpayer itemizes the deduction (as opposed to the standard deduction).
Interest must accrue on a “qualified” student loan that is used to pay for qualified higher education expenses. This means that the loan covers the cost of attending the eligible educational institution and may include tuition/fees, student activity fees, books, and other expenses that the IRS deems necessary.
An eligible educational institution is any college, university, or professional – a technical school that is eligible to participate in a financial aid program administered by the US Department of Education. It also includes postgraduate studies.
ALSO CHECK: TAX ATTORNEYS | Responsibilities and Salary
Cases Under Which A Personal Loan Will Qualify For Tax Benefits
Investment in business
If the personal loan amount was invested in the business, the interest paid can be claimed as an expense. This will reduce the borrower’s tax liability and reduce the net taxable income of the business in which he invested. There is no cap on the amount that can be claimed in this case.
Investment for the purchase/construction of residential real estate
A borrower can take advantage of personal loan tax credits if they have used the personal loan funds to buy or build a residential property. Borrower can avail tax benefits for repayment of interest on the same under Section 24 of Income Tax Act, 1961.
The maximum amount that can be claimed as tax deduction in this case is Rs 2,00,000 per house occupied by the borrower. There is no limit on the maximum amount that can be claimed if the house has been rented out to someone else. It is important that the borrower owns the property to take advantage of the tax benefits.
Investments in assets
The third and final case where personal loan tax deductions can be availed is when the loan amount has been invested to purchase assets such as jewellery, non-residential property, shares, certain shares, etc.
The borrower cannot claim a deduction in the same year that the interest is paid, but it will be added to the purchase price. The borrower can claim tax relief in the year in which he sells the asset.
ALSO CHECK: FORM 911: How to Request a Taxpayer Advocate Form
CONCLUSION
Do you want to borrow money for your wedding or are you planning to go on vacation, but don’t know how to do it? In such cases, you can apply for a personal loan. Personal loans have simple terms and conditions and are easy to apply for. Many people also don’t know that personal loans have an added benefit as they can provide tax benefits.
Are you planning to apply for a personal loan, but are you wondering if a personal loan is taxable? Or are you paying EMI and wondering if you can avail tax benefit on personal loans? This article tells you everything you need to know about personal loan tax benefits.
PERSONAL LOAN TAX DEDUCTION FAQs
What Happens When A Personal Loan Is Forgiven?
In rare cases where a lender forgives a portion of a personal loan, the borrower may be required to pay taxes on the forgiven amount. That’s because forgiveness turns that portion of the loan into income.
For example, if you got a loan for $10,000 and $2,000 is forgiven, you’ll have to pay taxes on $2,000. If the debt cancellation is taxable, you should receive a Form 1099-C from the debt collector or creditor with information about the amount cancelled.
How Do I Claim Personal Loans For House Construction?
Personal home construction loans can be claimed as expenses. If a person took out a loan to build his own house, the interest can be claimed as an expense. This is provided under Section 24 of the Income Tax Act and applies even to house renovations.
You have to keep in mind that in order to avail tax benefits on personal loans, you must be a property owner. You can claim the interest on such a loan as an expense, provided you took it out and paid it out of your own pocket. However, if you have availed such a loan through any other source like your parents or relatives, you cannot claim the interest as expenses.
Can I Use A Personal Loan For Taxable Investments?
If you use the money from your loan to invest in stocks, mutual funds or bonds, you can deduct any interest paid from your taxable investment. But be aware that there may be tax consequences in the form of short-term or long-term capital gains, and you will need to itemize your deductions to take advantage of this deduction, which is not common.
