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What are the tax implications of personal loans?
How borrowing and lending money might affect you this April.
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Borrowing money? Here are the tax implications
Are personal loans considered taxable income?
For the most part, no. When you receive a loan, it’s not considered taxable income. Taxes come into play on the part of the lender and usually aren’t something that you need to worry about.
The only exception is when a loan is forgiven. Cancellation of debt (COD) income is when your lender doesn’t require you to repay your loan’s principal or interest. Suddenly the loan becomes income simply given to you by the lender. Typically, if you receive a Form 1099-C from a lender, then you’ll have to report the amount on that form to the IRS as taxable income. You might receive this form after:
- Modification of a loan on your principal residence
- Return of property to a lender
- Abandonment of property
Even with COD income, there are exceptions. If you filed for Chapter 7 or Chapter 13 bankruptcy and your debt was discharged in a Title 11 bankruptcy proceeding, then you won’t have to pay taxes on that debt. Another example is forgiveness in the form of a gift. If you’re forgiven an amount that’s less than your liabilities minus your assets, you’re off the hook for paying taxes for that amount.
Are personal loans tax deductible?
No, repayments on a personal loan are not tax deductible. Just as funding from it isn’t considered taxable income, making payments on a personal loan — or on interest for it — isn’t deductible.
However, there are some exceptions. Here are a list of uses for personal loans that are tax deductible:
- Business expenses
- Qualified education expenses
What loans are tax deductible?
You may have heard that certain loans are tax deductible, and you heard right. Interest payments on the following loans are usually tax deductible:
- Student loans. If you’re paying off your student loans, you can deduct up to $2,500 in interest per year. Deductions only apply if you’ve taken the loan out from a qualified lender. Private loans from friends and family aren’t deductible. Use the IRS’s tax assistant tool to see if you can deduct the interest you paid on a student or educational loan.
- Mortgages and home equity loans. You can deduct interest on the first $750,000 of your first or second mortgage if you’re filing a joint return. Married taxpayers filing a separate return can deduct interest on the first $350,000. Home equity loans are only tax deductible if the loan funds go toward improving, buying or building your home.
- Business loans. Very specific requirements and qualifications go into deducting business loan interest payments from your taxes. If you’re using the loan for business and personal reasons, then you can’t deduct the entirety of the interest payments — only the percentage of those used to fund your business.
Remember that with all things tax related, there are exceptions. Be sure to double-check with your CPA before filing.
An example of how these tax deductions could affect your tax payments
Let’s say you made $100,000 last year and you paid $20,000 in interest on your mortgage. You can deduct $20,000 from $100,000 for a new taxable income of $80,000. This drops you from a 24% tax bracket to a 22% tax bracket, saving you money. The difference between 24% of $100,000 and 22% of $80,000 is $4,750. This is how much the mortgage interest tax deduction dropped your tax bill.
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Lending money? Tax implications to know
Is the interest from money I lent to a friend considered taxable income?
Yes, the interest payments you receive are taxable. Even when you don’t include interest, the IRS may treat would-be interest as taxable.
When it comes time to do your taxes, you’ll need to file Form 1099-INT to avoid being dinged by the IRS. For Form 1099-INT, you’ll need a few pieces of information:
- Your full name and address.
- The Social Security number of the person you loaned money to.
- The income you made on interest.
- Any tax-exempt interest.
Do I have to charge interest on a loan to a family member?
There is no easy answer to this one. Some experts advise that you charge interest on a loan to a family member no matter what to avoid tax complications. The government may end up taxing you on interest that you should have charged, or taxing it as a gift.
Gifts come with an annual exemption limit. In other words, every year there is an amount that you can gift to someone without paying taxes on that gift. For 2018, that amount is $15,000.
If you were to gift your family member $10,000 and they were to gift you that amount back over time, you could be circumventing certain rules. No taxes would need to be filed, and no interest would need to be charged.
What’s the difference between a gift and a loan?
Gifts are any amount that you give under $15,000 a year. For anything below that, the government doesn’t need to know why it was given or if it’s being paid back.
For loans greater than that, you should follow the IRS guidelines for charging interest. This includes looking at the applicable federal rate (AFR) and filing income tax on the interest payments you receive.
If you give more than $15,000 to one person throughout the year as a gift, then you’re required to file a gift tax form.
The tax implications of personal loans can be confusing. Keep in mind that whether you’re borrowing or lending, there are ways for you to investigate deductibles and payments. As frustrating as it can be, getting the research done ahead of time can save you time and money down the road.
Before you file, be sure to speak with a qualified tax professional if you have any questions.
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