Personal loans: Are they taxable income?

Personal loans can cover nearly any expense and are generally not considered taxable income unless the loan is forgiven. If your personal loan is forgiven, the money you borrowed becomes cancellation of debt (COD) income. You must report the COD income when you file taxes for the year the loan was forgiven.

Is a personal loan tax deductible?

Personal loans’ tax deductions depend on how you use the money. When personal loans are used for personal needs, including debt consolidation, you are not able to deduct payments from your annual income for tax purposes.

In cases where you use the proceeds from a personal loan to cover business expenses, you may be able to deduct the interest you pay on a loan from your taxes. In order to deduct the loan interest, you will need to itemize the expenses you spent the money on when filing your business tax return.

What is taxable income?

Taxable income generally includes any salaries, wages, freelance earnings, tips and bonuses a person brings in during a given year.

Some income is nontaxable, including:

• Accident and personal injury compensation.
• Alimony.
• Child support.
• Federal tax returns.
• Grants.
• Money gifts.
• Scholarships.
• Veteran and welfare benefits.

A forgiven personal loan sum is money the taxpayer received and never paid back. Therefore, it can be considered a source of income and is often taxable. Generally, you will have to pay taxes on a forgiven personal loan unless the loan was forgiven as a gift from a private lender.

When are personal loans considered taxable income?

Income is classified by the IRS as money you earn, whether through work or investments. A personal loan must be repaid and cannot be classified as income unless your debt is forgiven.

If you do not intend to seek debt cancellation for your personal loan, you do not have to worry about reporting it on your income taxes. If you have canceled debt, it is important to understand how that could impact your taxes this year.

Cancellation of debt (COD) income

If you are struggling to pay outstanding debt, you can do some things to get that debt forgiven. These options include negotiating with the lender, utilizing debt settlement programs and filing for bankruptcy.

If the lender agrees to cancel your debt, they will issue a COD and send you a 1099-C form. You are required to report the canceled amount on this form and submit it to the IRS when you file taxes.

Exceptions to the COD income rule

In some situations, you do not have to report the forgiven loan amount as income. If the amount is forgiven as a gift from a private lender, or if the debt is forgiven in the lender’s will, the amount does not have to be reported as income.

Additionally, taxpayers do not have to pay taxes on forgiven mortgage debt up to $750,000 due to the Mortgage Debt Relief Act passed during the Great Recession. The Consolidated Appropriations Act of 2020 extended these tax exemptions for forgiven mortgages to 2025 in light of the COVID-19 pandemic.

Are interest payments on personal loans tax deductible?

A tax-deductible expense is money a taxpayer can subtract from their overall gross income to reduce their reported income and, therefore, the taxes they have to pay. Unlike other types of loans, personal loans are generally not tax deductible.

Interest payments on student loans, mortgages and business loans can be reported as tax deductions. However, personal loan interest payments only qualify as tax deductible under certain circumstances. If you can prove that a personal loan was used to pay for business expenses, for example, the interest payments for that loan may qualify as tax deductible.

What happens if a personal loan is forgiven?

If you default on a personal loan but the debt is canceled or forgiven, the amount forgiven becomes taxable income. In such cases, you should receive a 1099-C form from the lender that can be used to claim the forgiven debt as income when filing your tax return. The 1099-C will provide information about the amount of debt and when it was forgiven.

The IRS requires that canceled debt be reported on tax returns for the year the cancellation took place. The forgiven debt is reported as ordinary income. There are some exceptions to this reporting requirement. If the debt forgiven by a lender is considered a gift, then it is not required to be reported as income.

In this instance, you’re not on the hook for the forgiven amount since a gift has its own tax stimulations through estate and gift tax. This won’t impact your tax return unless more than $16,000 is forgiven.

The bottom line

If you took out a personal loan last year and are unsure how it will impact your taxes, consider whether the debt was forgiven. If your personal loan was canceled and it was not done so as a gift by a private lender, you have to report the unpaid balance as income for that year using a 1099-C form provided by the lender.

If you are struggling to pay off a personal loan and would like to try to have your debt forgiven, there are resources available to help you figure out how to negotiate with lenders and work with debt relief companies.

For more information and resources on how to file your taxes, check out Bankrate’s tax resources page.