Are Personal Loans Taxable?

If you’ve borrowed money for debt consolidation or a major expense, you may wonder if personal loans are taxable. You don’t usually owe taxes on a personal loan because the money you borrow is considered a liability, not income.

But a few situations could result in a tax bill, like if the loan is forgiven or cancelled. While you typically won’t owe taxes on money you borrow, you also can’t deduct the interest you pay on a personal loan in most circumstances.

Are personal loans considered taxable income?

Personal loans aren’t considered taxable income because they’re a type of debt.

While a personal loan provides you with a lump sum of money that you can spend like income, you must repay it. That makes it a liability rather than taxable income.

A personal loan used for a common personal expense such as debt consolidation, a home improvement project or a wedding is unlikely to have any impact on your tax filings.

However, the loan may become relevant to your taxes if you use the funds in certain ways or if the lender forgives part of the debt.

One common misconception is that borrowing money reduces your taxable income.

The interest you pay on some types of loans, like a mortgage or student loan, is often tax-deductible. However, any reduction to your taxable income is the result of deducting the interest you paid on your debt, not borrowing money.

Personal loan interest is not tax-deductible in most situations, so taking out a personal loan won’t lower your taxable income or tax bill.

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What happens if a personal loan is forgiven?

In the rare instance when a lender forgives a portion of a personal loan, the loan is no longer a liability. The borrower receives a permanent benefit that they don’t have to repay, so the IRS will usually treat the forgiven amount as income and the borrower may need to pay taxes on it.

For example, if you receive a $10,000 loan and the lender forgives $2,000 of it, you may need to pay taxes on the $2,000.

If more than $600 of your debt is canceled, you’ll receive a Form 1099-C from the lender or debt collector with information about the canceled amount. Regardless of the amount, the forgiven debt should be reported on your tax return as income, according to the IRS.

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Is personal loan interest tax deductible?

Unlike interest on a mortgage or student loan, personal loan interest is typically not tax-deductible.

However, there are a few instances when you may be able to deduct the interest, depending on how you use the funds:

• If you use a personal loan to cover business expenses: The interest you pay could be tax-deductible. But if you used the loan for both business and personal expenses, you can only deduct the interest on the portion of the loan that went toward business costs. 

• If you pay for college with a personal loan: Most lenders prohibit you from using a personal loan to pay for tuition. However, if you took out a loan that you used exclusively for educational purposes, you can deduct up to $2,500 of interest payments.

• If you borrowed money for certain taxable investments: You may be able to deduct loan interest if you used the funds to buy some taxable investments, but the rules are complex. To take advantage, you’ll need to itemize your return instead of claiming the standard deduction.

Note that tax laws vary by state. If you’re unsure if a personal loan will have state tax implications, consult with a tax professional.

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