Is personal loan interest tax deductible?

Key points

• Personal loan interest is not tax-deductible on a general basis, but certain uses could potentially qualify you to deduct interest or expenses paid.
• Certain lenders may restrict your use of personal loan funds to non-deductible purposes.
• Even if interest or expenses are deductible, consider the costs before applying for a personal loan.

Personal loans are versatile, allowing you to use the proceeds for a variety of purposes. Since the Tax Reform Act of 1986, though, the personal interest you pay is not deductible when it’s time to file your tax return, except in certain cases.

As a result, using your personal loan for debt consolidation, a large purchase, a wedding or other standard purposes won’t qualify you for a tax break.

However, there are some situations where you may be able to deduct the interest you pay and even the loan proceeds. Here’s what you need to know.

When is personal loan interest tax deductible?

There are only a few situations where the interest you pay on a personal loan is tax-deductible, including if you use the loan strictly for business expenses, qualified educational costs or eligible taxable investments.

Business expenses

While interest on loans for personal use isn’t typically deductible, you can deduct interest on a loan you take out for business purposes. Additionally, you can deduct expenses that are ordinary and necessary to run your business, which means that you may also be able to deduct the proceeds used for qualified business expenses.

With that said, it’s important to avoid mixing business and personal expenses if you want to maximize your tax benefits. If you can’t prove that you used the full loan amount for business purposes, the math required to determine which portion of interest is deductible and which isn’t can be challenging.

Mixing business and personal expenses can also limit your personal protection from business creditors and lawsuits. “It’s important to protect your personal assets and be able to take the tax advantages that come along with owning a business,” says Scott Curley, co-founder of FinishLine Tax Solutions.

Also, note that some lenders may not allow you to use your loan funds for business purposes, so be sure to read the loan agreement carefully or ask before you apply to find the right option for you.

Finally, keep in mind that while personal loans may be beneficial when you’re just starting out with a business, they won’t help you establish your business credit history, so you may want to consider other options, such as a business credit card or an online business loan.

Qualified educational expenses

If you take out a personal loan for educational purposes, you may be able to get the student loan interest tax deduction and certain tax credits. According to the IRS, a loan is a qualified student loan if you took it out solely for educational purposes that were:

• For you, your spouse or a person who was your dependent when you took out the loan.
• For education provided during an academic period for an eligible student.
• Paid or incurred within a reasonable period of time before or after you took out the loan.

Additionally, you can’t be married and file separate tax returns; you must be legally obligated to pay interest on the loan; you can’t be claimed as a dependent on someone else’s tax return; and your income must be below certain limits that are set each year.

If you do qualify, you can deduct up to $2,500 in interest paid or the amount you paid, whichever is less. You may also be able to take the American Opportunity Tax Credit or Lifetime Learning Credit on the actual expenses you pay with your loan proceeds.

Note, however, that some lenders may not allow you to use your loan funds for educational purposes. Also, if you qualify for federal financial aid, federal loans offer the benefits of lower interest rates, longer repayment terms, deferment while you’re in school and more.

Eligible taxable investments

If you take out a personal loan and use the proceeds solely to make taxable investments, the interest you pay may qualify for the investment interest expense.

That said, this tax deduction is available only if you itemize your deductions instead of taking the standard deduction, which doesn’t make sense unless your itemized deductions exceed the standard deduction for your filing status.

“There is a high-risk factor associated with investments,” says Curley, so depending on the interest rate on the loan, it might not be worth it to borrow for short-term investments.

Also, like the other exceptions we’ve discussed, some lenders may not allow you to use loan funds to make investments.

Speak to a tax professional before trying to get a tax deduction on a personal loan

Because there’s no general personal loan interest deduction and we’re talking about specific exceptions, it’s important to avoid trying to go it alone if you want a tax deduction on a personal loan.

If you deduct something you’re not supposed to, it could result in penalties if the IRS audits your tax return.

“Due to the complexity of the IRS codes and their constant evolution, it’s important to work with an experienced tax professional who understands these changes,” says Curley.

If you’re considering a personal loan for one of the above purposes, take your time to shop around for a tax professional before you apply for the loan.

Frequently asked questions (FAQs)