Is Personal Loan Interest Tax Deductible? Unlocking Tax Savings in 2023

The IRS doesn’t recognize personal loans as income. Consequently, deducting loan interest payments from your taxable income is usually not an option unless the funds you borrowed were used for a qualified investment, education expenses, or business expenditures.

In other words, you won’t be able to deduct the interest you pay to a lender from your taxes if you take a personal loan to go on a vacation with your family.

However, if you use the money to buy a vehicle that you use predominantly for professional purposes, you might not be able to claim a part of the entire loan interest as a tax deduction.

In this guide, we’ll show you how to determine if your personal loan interest is tax deductible and help you unlock tax savings in 2023.

What is a Personal Loan?

Personal loans are attractive because you don’t need collateral securities to get them. Lenders are unlikely to approve a mortgage or an education loan if you don’t have sufficient collateral.

This isn’t the case with personal loans, as lenders don’t need collateral to approve them. Instead, they look at the following parameters:

• Debt-to-income ratio
• Credit score
• Annual income
• Loan’s life duration
• The loan amount

Most loan terms vary from two to seven years, although some lenders offer long-term loans you can pay off for twelve years. The maximum personal loan amount you can borrow from a bank or online money lenders ranges from $1,000 to $100,000.

Interest Rates

Your personal loan’s interest rate depends on the amount you borrow, your credit score, and the payment term. Generally, personal loans with longer payment terms have higher interest rates than short-term loans.

The average personal loan interest rate in 2023 is 10.97%, but your interest rate depends on your chosen lender and loan terms.

Banks usually offer lower interest rates on personal loans than online lenders, some of which can require monthly payments that exceed 30% of the borrowed amount. Your interest rate will likely be lower if your credit score is higher than 720.

Personal Loan Interest Tax Deduction Exceptions

Unlike home equity, mortgage, student, and business loans, personal loans are not tax deductible. Still, there are a few exceptions to this rule that might enable you to claim a personal loan interest tax deduction.

Most people use personal loans to consolidate debts, refinance a loan or cover unexpected medical expenses. However, you can’t deduct interest rates from your taxes if you use the funds you borrow for these purposes.

Using the loan to pay for education or business costs and certain investments will make you eligible to deduct the monthly interest rate from your taxable income, but only if you meet specific criteria.

Investments

Buying stocks or bonds with funds you borrow can make you eligible for a personal loan interest tax deduction. However, you can only do so if you opt to itemize deductions on your tax return.

Claiming a personal loan interest as a tax deduction isn’t possible if the funds were used for investments that provide tax advantages, and the borrower can only claim the deduction for the portion of the loan utilized to make the investment.

So, you can’t deduct the entire interest amount from the taxable income if you didn’t invest the whole sum you borrowed. Deducting personal loan interests is also possible if you invest the funds in an S corporation, a trust fund, LLC, or a partnership.

It’s advisable to consult with a tax professional who can help you understand the rules and circumstances under which you can deduct interest from your taxes after using a personal loan for investment purposes.

Higher Education Fees

You can deduct personal loan interest from your taxable income if you use the funds to pay for the costs of higher education. So, at least in theory, you can deduct the interest from your taxable income if you can prove that the personal loan was used to pay for the expenses below:

• Learning materials
• Accommodation
• Tuition
• Commuting expenses

Most money lenders don’t allow borrowers to use personal loans to cover educational expenses because they’re not subject to the same requirements as student loans.

The Higher Education Opportunity Act of 2008 requires lenders to provide a 30-day rumination period and meet a broad spectrum of conditions when issuing student loans.

Consequently, borrowers are reluctant to approve a personal loan that will be used to pay higher education expenses because these loans don’t meet the requirements stipulated in HEOA.

You’ll be able to deduct interest from your taxes if you manage to secure a personal loan you can use to pay for higher education fees. Still, you cannot deduct more than $2,500 of student loan interest annually from your taxes.

This deduction is available to single filers whose modified adjusted gross income exceeds $85,000 or parents who claim their children as dependents.

Taxpayers who choose the married filing jointly filing status cannot claim an interest deduction if they earn more than $170,000 per year, but couples that opt to file their tax returns separately cannot claim the student loan deduction.

Business Costs

The IRS’ Tax Guide for Small Businesses states that business owners can deduct some or all interest they pay as business expenses if the debt is related to their business.

Consequently, personal loan interest is tax deductible if you invest the funds you borrow in your business.

Taking a personal loan to rent an office, buy office supplies or equipment, purchase a car, and promote your business will enable you to deduct interest from your taxable income.

There are a number of rules you must follow. So, for instance, if you buy a car you use for private and professional purposes equally, you can only deduct 50% of personal loan interest as a business expense.

Tax Deductions And Other Loan Types

A certain amount of caution is necessary when deciding whether taking a personal loan is a good idea.

Aside from determining if deducting a personal loan interest from your taxable income is possible, you must also check if other types of loans would come with more favorable conditions.

For example, using a credit card could be a good option for relatively small purchases, as you won’t accrue any interest if you repay the debt by the end of the month.

Opening a personal line of credit, taking a 401(k) loan, or a home equity loan are also among the options you should consider before taking a personal loan.

These loans, along with conventional student loans, business loans, or mortgages, usually allow a taxpayer to deduct interest from the taxable income.

Most importantly, you must understand the terms of the loan you’re taking and its implications on your taxes before committing to it.

Frequently Asked Questions

Unlocking Tax Savings With Personal Loan Interest Tax Deductions

Taking a personal loan could be a great idea if you want to refinance a loan, renovate your home, or consolidate debt. Still, you won’t be able to deduct the interest you pay throughout the year from your taxable income.

Personal loan interests are only tax deductible under specific circumstances, so you’ll have to use the loan to invest in stocks or pay office rent to deduct interest from your taxes.

Personal loan interests can also be tax deductible if the funds are used to pay for the costs of higher education, but finding a lender that will approve such a loan is difficult. Hence, the way you use a personal loan will determine your tax savings in 2023.