Taking out a personal loan may have you questioning the tax implications that accompany such a financial endeavor. But it turns out, there’s probably no need to sweat what this means when April 18th rolls around. Here’s what you need to know about the tax implications of personal loans.
Is a personal loan taxable?
There aren’t many tax implications when taking out a personal loan, because these types of loans are not considered taxable income, explains Ted Rossman, senior industry analyst at Bankrate. And because they aren’t considered income, you don’t have to report them on your income taxes.
That said, there are times when a personal loan could lead to a tax bill for you — like when your debt is canceled or forgiven, explains Matt Schulz, chief credit industry analyst at LendingTree. “If your debt is forgiven or discharged for less than the full amount you owe, the debt is considered canceled in the amount that you don’t have to pay,” the IRS explains. “In general, if you have cancellation of debt income because your debt is canceled, forgiven, or discharged for less than the amount you must pay, the amount of the canceled debt is taxable and you must report the canceled debt on your tax return for the year the cancellation occurs.”
That, as Schulz explains, “can come as an unpleasant surprise to the borrower.” But, to be fair, this isn’t a common occurrence, though debt collectors may offer forgiveness in the event of bankruptcy or a debt settlement agreement.
In other words, in general, your personal loan is considered debt and as long as you’re on track to pay it back, you don’t need to worry about reporting it or paying taxes on it. It is, however, important to stay on top of payments because, “If part of your loan gets canceled, you may find yourself in a very different situation, one that may prove costly,” says Kaitlin Walsh-Epstein, senior vice president of growth and marketing at Laurel Road. Still, the personal loan in its entirety doesn’t need to be reported. “If you owe $5,000 on your loan and they forgive $1,000 of the value, you will need to claim the $1,000 on your taxes,” explains certified financial planner Stephen Carrigg, director of investment analysis at Integrated Partners.
But how do you know what exactly you’ll need to report your loan? Walsh-Epstein says a lender issues a cancellation of debt (COD) on the canceled amount. “This means you’re no longer responsible for paying back your loan and you’ll receive a 109–C form from your lender that you’ll need to submit with your tax return when you file and report the canceled amount,” says Walsh-Epstein.
Is personal loan interest tax-deductible?
The answer is usually no. Unless a personal loan’s proceeds are being used for business expenses, qualified higher education expenses or eligible taxable investments, the interest on unsecured personal loans can’t be deducted the way mortgages and student loans are.