Can you deduct personal loans when filing taxes?

Everyone loves tax deductions. So, when tax season comes around, one common question about credit always pops up: Can you write off personal loans?

Sadly, the short answer is no.

But, there are circumstances where interest on personal loans is deductible. Let's look at those as well as the potential justification for using personal loans for the purpose of tax deduction.

What part of a personal loan is tax deductible?

When you take out a loan, you have to repay the amount borrowed plus interest.

For instance, a $11,000 personal loan with an 11.5% interest rate typically lasts two to five years. Let's say you took a two-year loan. By multiplying the original loan amount by the interest rate and number of years, you find your credit total cost: ($11,000 x 0.115) x 2 = $2,530 in interest, totaling $13,530.

Over two years, you would pay $13,530 for the initial $11,000 loan, equivalent to about 19% of the principal amount.

Since taking out a loan can be costly, the government sometime offers interest deductions on specific loans to encourage borrowing, stimulating economic growth.

When can interest on a personal loan be tax deductible?

Generally, personal loans are not deductible as they're considered consumer debt rather than investments. However, there are exceptions:

Business expenses

If you use a personal loan to cover both personal and business expenses, you may qualify to deduct the interest on the business portion.

For example, according to the IRS, if you borrow money and use 70% for business and 30% for a family vacation, you can typically deduct 70% of the interest as a business expense.

Qualifying business expenses include transport costs, office rent, supplies, machinery, and advertising essential to your industry.

Educational expenses

Your eligibility to deduct education loan interest is based on your Modified Adjusted Gross Income (MAGI). MAGI is your total income minus specific tax deductions.

To claim a deduction for personal loan interest used for tuition, your MAGI must be $85,000 or less ($175,000 or less for joint filers). Currently, the maximum deduction is $2,500 annually.

Qualifying expenses include tuition, fees, room and board, textbooks, supplies, and transport. However, taking out such a loan for education should be considered carefully, as most personal loans for tuition do not allow funds for these purposes.

Investment assets

Interest paid on loan money invested in stocks, bonds, or mutual funds may be tax deductible. This doesn't apply to tax-advantaged accounts like IRAs, 401(k)s, or municipal bonds.Remember, you can only deduct interest on the portion of a personal loan used for a qualified investment. Also, you must itemize this deduction on your tax return.

How to Deduct Interest on Personal Loans

The IRS limits personal loan interest deductions to the amount paid. Also, the loan amount cannot exceed the fair market value of the purchase it financed.Here are five steps to ensure your tax return is accurate:

• Gather information: Loan agreement, statements, and receipts are needed
• Calculate interest paid: Refer to loan statements or contact your lender
• Determine deductible amount: Only a portion of interest is deductible
• Claim the deduction: Itemize deductions on Schedule A of your tax return
• Keep records: Retain all supporting documents for at least three years in case of IRS verification

Benefits of Using Specialized Loans for Education and Business

Choosing student or business loans for educational or business expenses has several advantages:

Interest rates

Specialized loans may offer lower interest rates and longer repayment terms. For instance, student loans average 5.8% interest, while personal loans can be 11%.

Additionally, student or business loans can extend up to 20-25 years, compared to personal loans of two to seven years.

Specific benefits

Student loans may offer deferment options or loan forgiveness for specific careers, such as public service. Business loans come with tax benefits and are tailored to individual needs.

Building credit

Specialized loans build a positive credit history, showing responsible borrowing to lenders.

When to Consider Personal Loans for Education and Business Expenses

While personal loans are not always ideal, they can be considered in certain situations:

• Small business funding: Start-ups lacking credit or collateral can use them

• Education expenses: Fully using financial aid but needing additional funds for books or living expenses
• Flexibility: Unlike other loans, personal loans have no spending restrictions and are quickly processed

Hiring a Tax Professional to Claim Personal Loan Interest

Claiming personal loan interest deductions can be complex due to percentage calculations.

For this reason, consult an experienced tax professional to ensure compliance with tax laws, minimizing errors and penalties. They maximize deductions, optimizing personal income taxes.