Is Personal Loan Interest Tax-Deductible?

Is Personal Loan Interest Tax-Deductible? article image.

In many cases, the interest you pay on personal loans is not tax deductible. However, you may be able to take a tax deduction if you use the loan for certain, specific purposes and meet all the eligibility requirements.

Can You Deduct Personal Loan Interest on Your Taxes?

You can't deduct an unsecured personal loan's interest on your taxes unless you use the loan's proceeds for one of the following purposes:

  • Business expenses
  • Qualified higher education expenses
  • Taxable investments
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Business Expenses

There are many costs associated with forming or running a business, and you may need to take out a loan to cover them. The interest accrued on this loan may be tax-deductible depending on what you use the funds for. You don't necessarily need to run a large business either; you could qualify even if you have a side gig as a freelancer or consultant.

The interest associated with a loan used to purchase supplies for a product you create and sell online or to buy furniture for a rental property, for example, may be considered a business expense. You can subtract the expense from your business's income, which can reduce your tax liability for the year. If your expenses exceed your business's income, you may have a loss for the year that could offset other types of income.

If you use a personal loan for personal and business expenses, you can only deduct the interest associated with the portion of the loan you use for the business expenses.

Qualified Educational Expenses

Most people take out federal or private student loans to pay for higher education, and for good reason. Student loans often have special repayment plans that better align with students' needs compared with other forms of debt. Furthermore, most federal student loans don't require a credit check and can qualify for forgiveness and hardship programs.

However, if you use all the funds from a personal loan to refinance a student loan or pay for qualified educational expenses—such as college tuition, fees and required activity fees—it may count as a qualified student loan. As a result, the interest payments could qualify for the student loan interest deduction, and you may be able to deduct all the interest you paid for the year.

The student loan interest deduction is particularly valuable as it's an above-the-line deduction (technically making it an adjustment rather than a deduction). You can claim it even if you itemize your deductions, and it may help you qualify for other tax deductions or credits.

However, there are also requirements and limitations. For example, you can't claim the deduction if your tax filing status is married filing separately, and the deduction's amount may be reduced depending on your modified adjusted gross income for the year. The loan also must be for you, your spouse or a dependent while they're enrolled at least half-time in a recognized degree, certificate or credential program.

Taxable Investments

You may also be able to deduct interest on a loan if you use the money to purchase taxable investments, such as certain stocks, bonds or mutual funds. But the deduction isn't allowed for purchases of tax-advantaged investments, such as tax-exempt bonds. If you use the loan for different purposes or types of investments, you can still take a deduction for the interest that corresponds with the amount you use for qualified investments.

You'll need to itemize your deductions to take the investment interest deduction, which means most people won't benefit from it. Additionally, you can only deduct interest to offset investment income for the year. If you don't have enough investment income, you can roll over qualifying interest payments to the next year to offset future investment income.

Are Personal Loans Taxable Income?

You usually don't pay income taxes on the proceeds from a personal loan because you need to repay the money. However, if the lender forgives or cancels some of your debt, the portion you don't have to repay may become taxable income.

For example, if you're repaying a federal student loan with an income-driven repayment plan, the remainder of your loan may be canceled after 20 to 25 years. Your lender may then send you (and the IRS) a Form 1099-C showing how much debt was canceled, which you'll include in your tax return.

A similar situation can happen if you settle a debt with a creditor for less than you owe or negotiate a debt reduction. Overall, you may save money, as paying taxes on $1,000 in forgiven debt will be less expensive than paying the entire $1,000. However, you want to be prepared for the tax consequences.

There are a few exceptions and exclusions when you don't have to include forgiven or canceled debt in your taxable income. For example, if you qualify for certain federal student loan forgiveness programs, such as the Public Service Loan Forgiveness program, the forgiven amount won't be taxable.

More generally, when your debts are canceled or forgiven and you have more liabilities than assets (you're insolvent, in other words), part or all of the forgiven amount may be excluded from your income. Also, your debts that are discharged when you file bankruptcy don't become taxable income.

Getting a Good Rate on Your Personal Loan

While you may be able to deduct the interest you pay on a personal loan in certain circumstances, you still want to minimize how much interest you pay in the first place. Shopping for a loan from multiple lenders and building your credit before applying can help you find and qualify for the best rates. If you want to quickly compare options from multiple lenders, Experian's personal loan tool lets you quickly compare and sort lenders' loan options.