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What are the tax implications of personal loans?
How borrowing and lending money might affect you in April.
Updated . What changed?
Personal loans don’t always play into your taxes. But in the few situations where it counts as income — or if your interest payments are tax deductible — you need to report it.
Are personal loans considered taxable income?
No, personal loans aren’t considered taxable income — in most situations.
However, you will have to pay taxes if your debt is forgiven or canceled. Cancellation of debt (COD) income is when your lender doesn’t require you to repay your loan’s principal or interest. The loan will be considered income at this point, and you should receive a Form 1099-C from your lender. You will need to report the forgiven amount on that form to the IRS as taxable income.
You might receive Form 1099-C 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. And 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.
How loan forgiveness could affect your tax payments
If a lender canceled all or part of your loan, it will be considered income. For example, if a lender cancels $5,000 of loan principal, you will need to adjust your income up by that amount when you report it during tax season. And if it changes your tax bracket, you may need to pay a different percentage of income tax on a portion of the loan.
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:
- Qualified education expenses
- Business 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.
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Lending money? Tax implications to know
If you plan on lending a friend or family member money — or have already lent money — there are some tax implications you should take into account.
What to keep in mind when lending money to friends and family
Remember that unless you draw up a full loan contract with the person you’re lending to, the person may not be legally obligated to pay you back. If you’re lending a large amount of money, you may want to consider having a documented contract.
In general, lending money to family or friends could cause tension in the relationship. One idea to consider is only giving money to family or friends that you can afford to not get back.
It’s also important to talk through the tax implications with a tax professional if you’re unsure of what to file. Instead of getting through your taxes and finding out that you owe much more than you set aside, work it out beforehand to save yourself potential frustrations.
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.
Is there a 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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