Are Personal Loans Tax Deductible?

A personal loan is a good option when you need money in a relatively short amount of time. Personal loans can help you cover the cost of home repairs and renovations, pay for emergencies, consolidate high-interest debt, and much more!

When it’s tax time, you could find a personal loan doesn’t come with as many advantages as other types of loans you have. Read on to learn more about whether or not your personal loans are tax deductible.

Are Personal Loans Tax Deductible?

The short answer to this question is no. You might be wondering why not, since (in most cases) you can deduct interest on mortgages, home equity loans, student loans, and business expenses. So shouldn’t you be able to do the same with personal loans?

A personal loan doesn’t affect your taxes because it’s a loan with the intention of being repaid. Because this isn’t income like money earned through your job, investments, or a side gig, it isn’t considered taxable.

Understanding Interest Deductions

It’s helpful to first understand what it means to deduct any kind of interest on your tax return.

When you take out a loan, you borrow a certain amount. This amount is known as the principal balance on your loan. You’ll pay interest on top of paying back the principal. Interest is what the lender charges you to borrow money.

When you can deduct interest on your tax returns, you essentially delete that amount from your annual income. So if you earned $45,000 in taxable income and could deduct $2,000 in interest, you’d only have to pay taxes on $43,000.

But when it comes to taxes, for every rule there are some exceptions. In the next section, we’ll cover exceptions to interest deductions.

Exceptions to Personal Loan Tax Deductions

Much like deducting the amount of a personal loan, you usually can’t deduct the cost of interest. However, you may be able to deduct your personal loan’s interest if you use it for one of our exceptions listed below. We’ll give you a closer look at each loan use and how you could potentially qualify for tax benefits:

Business Expenses

When you own a small business or work as a freelancer or consultant, you may need a loan to cover start-up costs. In some cases, this could be a personal loan, but a portion or all of this personal loan could be tax deductible if you apply it the right way.

If you use any part of the personal loan for business purposes such as renting office space, buying supplies, or hiring someone to create a website for you—you can deduct the interest associated with those expenses from your profit. This will then reduce your overall business income tax.

Remember, if you use a portion of the loan for a personal expense, you must keep track of the interest payments separately, since that portion is not tax deductible.

Qualified Higher Education Expenses

Higher education is expensive so taking out federal student loans to cover higher education costs can be a smart financial move. These loan types offer various benefits like forbearance, deferment, income-driven repayment plans, and loan forgiveness—whereas other loans don’t.

If you use all of the funds from a personal loan for qualified higher-education expenses, it may be counted as a form of a student loan by the IRS. This would make the interest you pay tax-deductible using the student loan interest deduction.

Take note of the few restrictions the IRS has on claiming this deduction:

• The personal loan must be for you, your spouse, or a dependent child while they’re enrolled at least half-time in a qualified higher education program
• You’re not eligible if you’re married and filing taxes separately
• The deduction will be based on your modified adjusted gross income (MAGI) for the year, meaning if you earn too much money, the interest may not be deductible

Investments

If you used a portion or all of the loan to buy a taxable investment, such as a stock, bond, or mutual fund, the interest you pay on that amount could be tax deductible. Remember the tax deduction can only offset the investment interest in order to reduce your tax liability on just the investment.

You cannot deduct this interest from your overall gross income, so it's generally not worthwhile to do this. Investments with tax benefits, like a 401(k) or IRA, aren't eligible for interest deductions and tend to be lower risk. These types of retirement accounts only require you to pay taxes when you withdraw funds.

Tax Deductible Loan Types

Since a personal loan generally isn’t tax deductible, you might consider a different type of loan that’s more specific to your needs and allows for a tax deduction. These loans might also offer lower interest rates, more manageable repayment terms, and other benefits.

Examples include student loans, mortgages, home equity loans, small business loans, and home equity lines of credit.

As an added bonus: these loan types generally offer more competitive interest rates and higher borrowing limits.

Apply Today at OUCU Financial

At OUCU Financial, we offer a variety of personal loans to our members. If you’re not a member already, we’re happy to get you started with the application process. Our guide to personal loans doesn’t stop here! Click below to learn more about personal loans to make your best choice.

Pros and Cons of Personal Loans