Are Personal Loans Taxable?

Personal loans can be useful when you need extra funds, since you can use them for a variety of purposes. With a personal loan, the lender gives you a lump sum that you’ll pay back with interest in monthly installments over time.

A question you may have is whether the funds you receive count as taxable income. While personal loans are generally not taxable, there are exceptions to the rule. To understand how personal loans may affect your taxes, it’s good to start with what constitutes taxable income.

[Read: Best Personal Loans.]

What Is Taxable Income?

Taxable income is your adjusted gross income

minus the standard or itemized deduction. Your gross income generally includes wages, salaries, commissions, tips and other compensation. You can get your adjusted gross income by subtracting student loan interest, educator expenses and other eligible amounts from your gross income.

Since you have to repay personal loans, they are generally not considered income that you’d need to report on your tax return.

However, as with many situations involving the IRS, there is an exception: If a portion of the personal loan is forgiven, discharged or canceled, meaning you are not required to repay it, you may have cancellation of debt income that should be included on your tax return.

[Read: Best Low-Interest Personal Loans]

Is Canceled Personal Loan Debt Taxable?

In most cases, canceled personal loan debt counts as income.

“The amount of canceled or forgiven debt is considered income and would be taxable in the year the debt was canceled,” says Dawn M. Schwartz, assistant professor of accounting at Longwood University.

For example, if your creditor cancels $3,000 of a $10,000 personal loan, you would need to report that $3,000 on your taxes, but not the $7,000 you paid back.

“The borrower should receive a Form 1099-C that reports the amount of canceled debt,” Schwartz says.

There are exceptions when canceled debt is still not considered taxable income. If the debt cancellation was part of a bankruptcy, for example, it would not count toward your gross income.

If you borrowed money from a friend or family member instead of taking out a personal loan from a bank, credit union or online lender, canceled debt won’t count as income if the cancellation is an eligible gift.

“The giver of the loan forgiveness may need to file a gift tax return if their gifts to this individual are greater than the gift tax reporting threshold during the given year,” says Leah Diehl, a certified public accountant and assistant professor of accounting at the University of Montana College of Business.

Is Personal Loan Interest Tax Deductible?

Tax deductible expenses are those you can subtract from your income before calculating the taxes you owe. In general, you cannot deduct personal loan interest. However, there are exceptions to this rule, too.

“For example, interest on personal loans may be tax-deductible if an individual uses the proceeds of the loan to cover business or qualified higher education expenses or if they use the proceeds to purchase taxable investments such as stocks or mutual funds,” says Michele Frank, associate professor of accountancy at the Farmer School of Business at Miami University.

[See: Best Personal Loans for Credit Card Refinance.]

Will You Owe Taxes If You Loan Someone Money?

Borrowing money from a friend or family member can be a good alternative to taking out a personal loan. If you pursue this, know it can come with its own tax implications.

“It’s common for individuals to give gift loans,” Diehl says. “In those cases, taxpayers may be subject to imputed interest rules.”

Imputed interest is the minimum interest the government would expect you to collect on a loan. The numbers the IRS uses to calculate imputed interest are called Applicable Federal Rates, and they update each month.

“The tax code requires that any gift loan of $10,000 or more have imputed interest,” Diehl says. “That means you must calculate the interest on the loan using the current Applicable Federal Rate,” and the giver of the loan must report the interest income, even if they didn’t collect interest.

For example, if you loan a friend $10,000 for one year when the Applicable Federal Rate for this type of loan is 4.5%, then the IRS would expect you to have collected $450 in interest during the year, if interest compounded annually. Under your amicable agreement with your friend, you may have received no interest, but you still need to report the $450 as imputed interest.

“Likewise, the recipient of the loan can deduct the amount of their required interest payments as an itemized deduction even if they haven’t made the payments,” Diehl says, so long as they used the loan for business expenses, education expenses or qualified investments.

“Additionally, if funds from a gift loan are used to purchase something that will generate income, such as investments or property for a business, then both the giver and recipient must report the imputed interest even if the loan amount is less than $10,000,” Diehl adds.

More from U.S. News

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6 Personal Loan Requirements You Should Know

Personal Loan vs. Personal Line of Credit

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