Key takeaways
- Since lenders require you to repay a personal loan, they are considered debt and not taxable income.
- If a lender forgives some or all of the loan, you may have to pay taxes on the forgiven loan amount.
- The IRS allows taxpayers to deduct interest on personal loan funds used for business purposes.
The funds you receive from personal loans are generally not considered taxable income unless the loan is forgiven. However, some scenarios allow you to deduct personal loan interest if used in connection with a business. Understanding how a personal loan affects your taxes can help you file accurate taxes and take advantage of deduction benefits.
Are personal loans taxable income?
A personal loan doesn’t generally qualify as taxable income because it’s a form of debt that must be repaid. Even though you receive all the funds at once, it’s not considered income if you pay it back as agreed. That’s true even if you use the proceeds for personal needs, such as paying for an emergency expense.
The IRS typically only considers income taxable if it’s earned from some type of employment, such as a salary or hourly wage. However, freelance earnings, self-employment income, tips, bonuses, and even gambling winnings are also considered taxable income.
The only exception to this rule is if some or all of your personal loan balance is forgiven or canceled.
How cancellation of debt (COD) income is taxed
If you can’t repay a loan and your lender fully or partially cancels your debt, the IRS considers any amount over $600 taxable income. This is known as cancellation of debt or COD income. It’s important to understand how it works when you file your returns.
- You’ll receive a 1099-C tax form. The lender will send this form to you if more than $600 of personal loan debt is canceled.
- You’ll pay taxes on the canceled amount. Make sure you provide this to a tax preparer so the amount can be added to your income for tax calculation purposes.
- Check eligibility for forgiveness exceptions. You may not have to report forgiven debt if it’s a gift from a private lender or if the debt is forgiven in the lender’s will.
Debt discharged as part of Chapter 7 or Chapter 13 bankruptcy is exempt from this rule.
What happens if you don’t report a 1099-C?
If you received a cancellation of debt from your personal loan lender through a 1099-C form, the IRS received the form, too. Failing to report that income could result in penalties and late fee assessments.
Tax deductions and personal loans
A tax-deductible expense allows taxpayers to reduce the total amount of the taxes they pay since it’s subtracted from their taxable income. Common examples of tax deductions for debt include interest paid on student loans, mortgages and business loans.
However, personal loan interest payments only qualify as tax-deductible under certain circumstances.
Are personal loan payments tax deductible?
You generally can’t deduct personal loan payments if you use the funds for personal uses like debt consolidation, emergency bills, or an uncovered medical expense. The same rule applies if you use the money for a major purchase like an RV or boat.
You also can’t deduct interest paid on personal loans for home improvement since your home doesn’t secure them. That tax benefit is reserved for borrowers who take out home equity loans or HELOCs to pay for renovations since your home is collateral for those types of loans.
Is interest on a personal loan tax deductible?
If you use any portion of personal loan funds for business expenses, you can deduct its interest from your tax returns. Examples of acceptable business uses include paying for office equipment, a new vehicle used for business or a new company laptop.
The IRS allows you to itemize those deductions as long as you can document the funds used for those expenses. One caveat: Some lenders restrict how personal loan money is used. Check the lender’s approval requirements before you apply for personal loans for business use.
Do I have to report a personal loan on my taxes?
In most cases, you don’t have to report a personal loan when you file your taxes if you pay it on time and use the funds for general purposes. The exception is if you default on a loan and receive a 1099-C form.
You should check with a tax professional to see if itemizing your expenses is worth it if personal loan funds pay for anything related to your business.
Tax implications of informal loans
The tax laws we’ve discussed so far apply to personal loans taken out from a financial institution like a bank or online lender. The rules are slightly different if you get a personal loan from a friend or family member.
These informal lending arrangements must meet certain IRS standards to avoid potential tax consequences.
Gift tax rules
The IRS expects a loan from a relative to resemble a loan from a bank. That means it should have repayment and interest terms. If the repayment terms can’t be documented, the funds may be considered a gift.
The 2024 gift limit is $18,000 per recipient. If someone gives you more than that in a single year, they must declare the gift by filing IRS Form 709 and the excess will be counted against their lifetime estate and gift exemption. However, since the lifetime exemption is $13.6 million, it is highly unlikely the gifter will owe any tax on that gift.
Bottom line
You generally don’t have to worry about any tax consequences for taking out a personal loan. Since it’s a debt, it’s not considered income.
If you’re self-employed, you may get some tax benefits if personal loan funds subsidize your business costs. It’s always a good idea to run any tax questions by an accounting professional to cover all your tax benefit and consequence bases.
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