Are Personal Loans Taxable?

Written by Jordan BlansitReviewed by Nathan Brown, CFP®Updated: 8th Apr 2022
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When tax season rolls around, it’s important to have your paperwork in order. Aside from your W-2, you’ll need to track down documents that outline your income, assets, and expenses.

And if you’ve taken out a loan in the last year, you may be asking yourself: are personal loans taxable – and where’s that darn paperwork?

Do Personal Loans Count as Income?

Personal loans are just that: loans. In other words, they’re an extension of credit – money that you have to repay. And since the money doesn’t usually increase your net worth, loans aren’t considered a wage, gift, or investment income.

Are Personal Loans Taxable?

Since personal loans are classified as debts, the IRS doesn’t consider them taxable income. You don’t have to report or pay taxes on-lent funds. And as long as you’re on track to repay your loan, that holds true.

But if part of your loan is canceled or forgiven, you may find yourself owing the IRS. (More on that below.)

Are Personal Loan Interest Payments Tax Deductible?

Some loans generate tax-deductible interest, including:

  • Student loans
  • Mortgages
  • And business loans

Additionally, if you use a personal loan to cover business expenses, you may be able to deduct the relevant interest.

However, personal loans used for personal expenses don’t come with the same tax benefits. In other words, most of the time, personal loan interest payments aren’t tax-deductible.

What Happens If You Cancel a Personal Loan?

Most lenders require you to cancel a loan during the application process, though some offer a limited cancellation window after you receive the money. But generally, once a loan is deposited into your bank account (or hands, as the case may be), you can’t really “cancel” it.

That said, you’re not necessarily out of luck. You may be able to use the loaned funds to pay off your debt immediately without incurring a prepayment penalty. Though you may still be on the hook for origination or administrative fees. However, early payment penalties vary between lenders, so you’ll need to read the fine print before you sign.

What Happens If a Lender Forgives Your Loan?

There are cases where your lender may cancel or forgive your loan. Generally, this occurs when you’ve defaulted on your loan and been sent to collections, or when you’ve filed for bankruptcy and are working with creditors on a mutually satisfactory repayment plan.

In these instances, your lender may issue a full or partial cancellation of debt (COD), which means you no longer have to repay that portion of your loan. You may also receive a 1099-C from your lender to file with your tax return.

Don’t rejoice just yet if you find yourself enjoying a canceled or forgiven debt. The IRS considers it taxable income because you don’t have to repay your loan. In other words, you’ll have to pay income taxes on the forgiven or canceled loan balance.

But exceptions and exclusions do exist. For instance, if your lender cancels your loan as a gift or part of your inheritance, you may not owe taxes. Additionally, if the lender seizes your collateral on a secured loan, the value of your property may count as a payment on your debt.

Bottom Line: How Personal Loans Affect Your Taxes

Personal loans can be a handy tool to help you with large purchases or get you through an emergency.

That said, it’s important to only borrow what you need, instead of relying on borrowed funds as a source of “income.” But no matter how you use your loans, you can rest easy knowing your personal loans aren’t taxed as income. (Usually.)

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Jordan Blansit
Jordan Blansit

Jordan Blansit is a Senior Writer, Researcher, & Product Analyst for SimpleMoneyLyfe with an inexplicable predilection for mortgages, investing, and personal finance. When she’s not click-clacketing from the comfort of her living room, you can find her in the California Redwoods or Oregon Siskiyous. Jordan’s areas of expertise are mortgages, personal loans, credit cards, and investing.