Can You Deduct Personal Loans From Your Taxes?
A personal loan is often a convenient, affordable way to get the funds you need for your next life goal. However, before taking out any loan, it’s a good idea to take a close look at the tax implications. Picking the right type of loan can help you save a lot of money on your income taxes. To see how a personal loan will affect your taxes, explore this helpful guide.
You Usually Cannot Deduct Interest From Personal Loans
To put it simply, the standard personal loan is not tax deductible. Personal loans are usually seen as a type of personal expense that is not related to your income tax. You don’t have to pay taxes on the income you receive from a personal loan, so it won’t make your taxes higher. However, you also cannot deduct any expenses related to the loan, so having the loan doesn’t typically make your income taxes lower.
Personal Loans vs. Business Loans
Since you can sometimes use a personal loan for business expenses, it’s easy to get the two concepts mixed up. However, technically speaking, they are two separate types of loans. You’ll need to know the difference between these financial services to understand how their tax deductions work.
Business Loan
A business loan is a loan that you received for the express purpose of starting a business. Before giving you the loan, the lender will need to review your business plan and make sure it’s financially viable. Business loans tend to have lower interest rates and provide larger sums of cash than personal loans.
Personal Loan
A personal loan is money you can use for anything you like. The lender won’t ask a lot of questions or make you provide them with a business plan. While you can use it for business expenses, you can also use it for things like paying off student loans or planning a wedding. Personal loans are easier to apply for, but they often come with higher interest rates and offer smaller sums of cash than business loans.
Exceptions That Allow You to Deduct Your Personal Loans
In most cases, the IRS does not allow people to deduct personal loan interest from their income taxes. However, there are a few small exceptions to this rule. You can deduct your interest if you use the personal loan for these purposes.
Business Expenses
Even if your personal loan is not a business loan, you can still typically use it for business expenses. In these cases, the interest from the personal loan is tax deductible. The interest from the loan will count as a type of business expense that reduces your overall profit, so it becomes deductible.
You can even deduct business expenses if you used part of the loan for personal matters. In these cases, you cannot deduct the full portion of the interest from your taxes. However, you can calculate how much interest you paid on the part of the loan that went toward business expenses and deduct that amount.
The great thing about this rule is that it’s very flexible. Business expenses don’t just refer to big, official expenses like hiring a new employee for your startup. Even small, personal, or freelance businesses can still have qualifying expenses. Here are some examples of ways that personal loan funds can become a deductible business expense:
• Work-related travel
• Supplies for an office
• Phone or internet costs
• Certain business meals
• Insurance costs for your business
• Space used as a home office
• Advertising expenses
• Health insurance for self-employed workers
• Fees for licenses or credentials
Certain Educational Expenses
If you took out a personal loan to pay for your student loans, you’re in luck. Not only can this be a good way to consolidate loans and reduce interest rates, but it can also help you save on taxes. As long as the personal loan goes toward a qualified student loan, you can deduct its interest from your taxes.
This is a particularly helpful tax deduction to take because it’s an “above-the-line deduction.” This type of tax cut is technically a tax adjustment, not a deduction. You can declare it even if you don’t use itemized deductions, so you save money no matter how you choose to organize your taxes.
You can also deduct personal loan interest that went toward other student expenses. Using it for things like books or student activity fees will make your personal loan interest into a deductible expense for your income taxes.
Another helpful thing to know is that this deduction applies to more than just you. In addition to using the deduction for your own educational expenses, you can also use it for your child’s expenses. As long as your child is still a dependent on your tax return, any of their qualifying educational expenses can also be deducted.
Some Types of Investments
The final way you can deduct personal loan interest from your taxes is if you use it to purchase a taxable investment. If you put the loan money into an investment that is itself taxable, the interest from the loan is taxable. Examples of investments that can lead to a personal loan deduction include:
• Stocks
• Bonds
• Mutual funds
Keep in mind that there are some qualifications you have to meet if you want to deduct your interest, though. First of all, you cannot use the loan for tax-advantaged investments like tax-exempt bonds. Also, the deduction can only be used to offset income from the investment. If you buy a stock that performs so poorly you lose money, you won’t be able to deduct your loan interest.
How to Calculate Deductions for Personal Loan Interest
So, how do you use your personal loan costs to save money on your taxes? Here are the basic steps you’ll need to know.
Find Out Which Loan-Related Costs You Can Deduct
You cannot deduct all the money you receive from the loan from your taxes. Instead, the part you deduct is the extra costs associated with the loan. If it’s a $5,000 loan that you paid the lender $500 for, the extra $500 in costs is the part you’d deduct. Tax-deductible loan expenses fall into two separate categories.
Interest
The interest rate is the extra money you pay each month along with your loan payment. On average, a personal loan rate ranges from 6% to 36% of the total amount of the loan. This is the main way that you can save money on your taxes.
Loan Origination Fees
Most lenders will charge a small fee for the process of writing and finalizing your loan. These fees are called loan origination fees, and they’re a flat rate you pay at the time you receive your loan. It’s usually a smaller deduction than your loan interest, but it can still be worthwhile to claim it.
Calculate the Portion of the Loan Used for Qualifying Expenses
It’s fairly common for people to use a personal loan for a combination of both business and personal expenses. If you’re in this situation, make sure you calculate your deduction properly, or you can end up owing extra money to the IRS. You can only deduct the portion of interest that went toward things like business costs, student loans, or investments.
For example, if you use $6,000 of a $10,000 loan for a business car and $4,000 for rent and groceries, 60% of the loan would have gone toward business expenses. Therefore, you could deduct 60% of your total interest costs from your taxes.
Follow These Tips for Filing Taxes Correctly
Any time you are deducting expenses from your taxes, you can expect your tax filing to take a little more time. However, saving money with deductions doesn’t have to be confusing or complicated. Just follow these tips to make sure you save as much money as possible with your personal loan and other tax deductions:
• Always keep careful records of your business expenses. This will make it easier to calculate your taxes, and it provides proof of your claims in case you get audited.
• Don’t hesitate to ask for help from a professional. An accountant can ensure you do your taxes right, and if you’re self-employed, the cost of hiring the accountant is another tax-deductible business expense.
• Track even small business expenses like gas because these costs can add up quickly over time.
• Read over the documents from your lender carefully. A good lender will provide you with tax documents that show the total cost of your interest, so you can easily deduct the right amount.
• Make sure you’re only deducting interest that you paid that year from your taxes. The amount of interest you pay each year changes as you pay off your loan, so you cannot deduct the same amount every year.
• Check with the IRS to be sure you’re using the right form. LLCs and partnerships typically deduct personal loan expenses on Form 1065 while individuals usually deduct expenses on Schedule C form. You might even have the option of using the shorter Schedule C-EZ form if your expenses are less than $5,000.
Get Started With Your Personal Loan Now
Ultimately, a portion of a personal loan can be tax deductible as long as you use it for a qualifying reason. If you’re interested in getting a personal loan, American Business Credit is here to help. Our team is happy to help you explore your options and see how much you could save on taxes with our various types of loans. We provide a convenient application process and reasonable interest rates. To learn more about our services, contact American Business Credit now.
