Do You Have to Pay Taxes on Personal Loans?
Could you owe tax to the IRS if you take out a personal loan?
At some point, there’s a good chance that you’ll face some type of debt. In fact, at the end of the third quarter of 2019, total consumer debt amounted to $13.95 trillion, according to the Federal Reserve Bank of New York’s Center for Microeconomic Data.
Most of that debt is from mortgages, but other types of debt are increasing as well. Non-housing debt balances rose by $64 billion in the third quarter, with increases seen across a variety of debt types, including auto loans, credit card balances, and student loans.
The New York Fed also said household debt in last year’s third quarter was much higher than the then-record $12.68 trillion reached in the third quarter of 2008 during the most recent global financial crisis.
One type of loan that is gaining in popularity amid this rise in household debt is the personal loan. Total unsecured personal loan balances increased to a record $156 billion in the third quarter of 2019, according to data gathered by credit reporting agency TransUnion.
However, even with that increase, personal loans still make up only about 2% of U.S. consumer debt, so some might not familiar with how they work—and how the IRS views them. Before you take out a personal loan, it’s a good idea to understand how one works, and its tax implications. So, are personal loans taxable? Let’s dive in.
Are Personal Loans Taxable When You Receive Them?
A personal loan is a flexible type of loan that can be used for almost any purpose. It can be unsecured, requiring just your promise to repay, or it can be a secured loan, requiring that you provide collateral that the lender can seize if you don’t make payments.
No matter the type of loan, it’s important to note that the IRS generally doesn’t consider loans as income. Instead, it recognizes that the amount you receive will be repaid at some point. As a result, you don’t usually have to report the amount of your loan on your tax return.
What Happens If Your Loan Is Canceled or Forgiven?
The next question many ask is, “Are personal loans taxable if they’re forgiven?” When answering this question, things get a little more complicated. If a portion of your unsecured loan balance is forgiven or canceled, you’re no longer expected to repay it—and the IRS can then consider that amount as income.
Your lender might send a Form 1099-C, which indicates the amount of the canceled debt. That is the amount you’re expected to report as regular income on your tax return. Let’s say you borrow $7,000. After repaying $3,000 in principal, you run into trouble and realize you can’t finish paying it off. The lender forgives the remaining $4,000 in principal. At tax time, you’re expected to report that $4,000 as regular income.
What About Secured Debt?
One exception might be if you have a secured loan and the lender claims the property as part of its payment for the debt. Depending on the loan contract, you may or may not have to report a portion of the canceled debt to the IRS.
- Recourse debt: After the lender claims your secured property, the difference between what you owe and the fair market value of the item is considered taxable. Using the example above, if you had secured the loan with an item that has a fair market value of $2,000, you can subtract that from the amount you’re taxed on, and you would report $2,000 in taxable income.
- Nonrecourse debt: If the secured loan contract is for nonrecourse debt, meaning you’re not personally liable for it, the fact that the lender repossessed the property is considered sufficient payment and you don’t have to report the canceled amount as ordinary income.
Before filling out your tax return, you might consider consulting with a tax professional who can help you determine what you owe.
Are Interest Payments Tax-Deductible?
Some types of loans, like student loans and business loans, can have tax-deductible interest payments if you qualify. You can reduce your income based on the interest you pay on these loans.
However, personal loans don’t come with the same tax benefit. If you get a personal loan, you generally won’t be able to deduct the interest you pay on taxes. The main exception, however, is if you can prove to the IRS that you used part or all of the personal loan for a business purpose. Consult with a tax professional before seeking this type of tax break.
In most cases, “No” is the answer to the question, “Are personal loans taxable?” However, there are times when you might have to pay taxes on amounts that are forgiven. Additionally, with a personal loan, you can’t expect to receive tax breaks on the interest you pay in most instances.
A personal loan might help you make a large purchase, support you in an emergency, or smooth your cash flow. But, as with all types of debt, it’s important to use the money borrowed wisely and to find alternatives before moving forward.
Federal Reserve Bank of New York's Center for Microeconomic Data. "Household Debt Continues to Climb in Third Quarter as Mortgage and Auto Loan Originations Grow." Accessed Jan. 13, 2020.
TransUnion. "Consumers Poised to Continue Strong Credit Activity this Holiday Season." Accessed Jan. 13, 2020.
Experian. "Personal Loan Debt Continues Fast-Paced Growth." Accessed Jan. 13, 2020.
Internal Revenue Service. "Topic No. 431 Canceled Debt - Is It Taxable or Not?" Accessed Jan. 13, 2020.
Internal Revenue Service. "Topic No. 456 Student Loan Interest Deduction." Accessed Jan. 13, 2020.