Though personal loans are not generally tax-deductible, mortgages, student loans, and business loans often can be. That makes sense when you think about it. Interest, after all, is paid on any money you borrow. So if you borrow more money to get a house or to go to school, you can deduct the interest on those loans from your taxable income for the year.
However, there are certain criteria to meet in order to qualify for these deductions. Mortgage interest on a loan is only deductible if the loan was taken out to finance the purchase of a primary residence. Alternatively, if someone has a very low income and they were issued a mortgage credit certificate through a government program, they may be eligible for a tax credit which reduces their income tax rather than their taxable income.
You should be able to afford a personal loan even without a tax break. If you’re interested in taking out a personal loan and want more information on what amount you can repay, calculate your personal loan by using one of the many loan calculators online for free.
Are Any Type of Personal Loans Tax-Deductible?
Generally, the answer is no. Loans to buy a car or cover other personal expenses are not tax-deductible. Interest paid on credit card balances is also not tax-deductible. There are a few exceptions. The IRS states that interest paid on personal loans is not tax-deductible if the interest is for something other than the purchase of a home, college education, or buying investments. For example, a home equity loan can be used to buy a car or cover other personal expenses and the interest from that loan may be tax-deductible. Interest paid on credit card balances in rare cases may be tax-deductible – in fact, if you can prove you were insolvent when you incurred the debt.
Highlights
- Normally, the interest paid on personal loans, credit cards or car loans are in most cases, not tax-deductible.
- Interest on qualified student loans is tax-deductible. Qualified educational expenses are things like tuition, fees, textbooks, and supplies.
- You will likely be able to deduct the loan interest that you paid while filing your year-end returns if you get a loan or pay interest on credit charges for business expenses.
Types of Loans with Interest That Are Tax-Deductible
Term Loan Interest
A term loan is a type of bank loan with a set timeline for repayment, traditionally between three and 20 years. You can pay back the loan either with a fixed or floating interest rate. After you sign for the loan, the bank will give you an amortization schedule which determines how much of your loan will be paid each month. Typically, interest on your loan is added to your monthly payments, so you can deduct the amount each year until the loan is paid in full.
Lines of Credit Interest
If you have a business line of credit, interest is calculated differently than with a term loan. A line of credit is similar to a credit card — you can withdraw funds from a preset limit of money, but there’s usually a larger funding limit than you would have with a credit card. With a line of credit, you only pay interest on withdrawals. What’s the interest rate on the money you borrow? If you withdraw $10,000 on a $50,000 line of credit during the year, you will likely want to consult your lender to see how much interest you paid on the $10,000 you withdrew.
Short-Term Loan Interest
Short-term loans are just like long-term loans, but are shorter in duration. Businesses use these types of loans for emergencies, such as the sudden need for immediate financing. Because of their small amount of requirements, these loans can be attractive to small businesses that want to grow their company quickly, but may not have the long track record necessary for more rigorous loan criteria. Because the length of a short-term loan is often 12 months or less, you may be able to deduct the interest paid on the loan in one annual tax return.
Personal Loan Interest
Businesses may prefer personal loans for business expenses. Such loans are sometimes simpler than bank or lender loans because they do not require an examination of your business credit. However, you should be careful how you use these funds. If the loan is used entirely for legitimate business expenses, then they are considered investments and can be deducted with interest payments. If you use money from your company’s fund for both business and personal reasons, you can only deduct the amount used for business. Which can become difficult to keep separated.
Student Loan Interest
Interest on student loans is tax-deductible as long as the borrower’s income is below a certain level. If the borrower’s adjusted gross income falls below a certain dollar amount, they can claim this as an adjustment to income. The result is the interest on the loan is deductible even if they itemize their deductions or take the standard deduction. The interest being deducted must be on a qualified student loan. Qualified loans are used to pay for qualified educational expenses such as tuition and fees, books, and other related products. This also includes higher education.
When is Business Loan Interest Not Deductible?
Your business loan interest is not always tax-deductible. While interest on business loans is often tax-deductible, there are exceptions:
- You can’t deduct the interest that you pay on a second loan if you use the money from the first loan. You can only deduct the interest on the second loan after you start making payments.
- Points and loan origination fees are not deductible as business expenses. They must be added to the value of the property, and then deducted over time with asset depreciation.
- Interest on a self-constructed, long-term asset cannot be deducted. This is called capitalized interest, and it has to be included in the cost of the asset.
- If you have funds on standby and your lender charges you fees to make sure they are available, this expense cannot be deducted as interest payments.
The Bottom Line and Loan Interest Tax Deductions
You can’t deduct your loan repayment, but you are able to take advantage of other deductions related to the interest you’ve paid. Plus, there’s a possibility that you can claim deductions for purchases or operating expenses related to your loan. When it comes to determining whether or not a loan is tax-deductible, the best source to check is the IRS.
