Are Personal Loans Taxable Income? What To Know

In most cases, personal loans aren’t taxable. If you borrow money and pay if off entirely, you generally won’t have to pay income tax on the loan proceeds. However, if you’ve had some of your loan debt forgiven, you could be on the hook for taxes. To understand how personal loans may impact you come tax time, first learn how these loans work and what counts as taxable income. 

What Are Personal Loans?

Personal loans are a type of installment loan from a bank, credit union or another type of lender. The loan proceeds you receive can be used for almost anything, from consolidating credit card debt to paying for home renovations or a vacation. When you take out a personal loan, you typically receive the funds in one lump sum, and pay it back over time on a set schedule. Lenders may charge a fixed or variable interest rate, depending on the lender and product you qualify for.

Typically, personal loans aren’t considered taxable income. The exception to this rule is when a personal loan is forgiven and it’s then considered a cancellation of debt (COD). It is then considered income, which is taxable in the eyes of the IRS.

What Are Personal Loans Used For?

There are many reasons for taking out a personal loan, including:

• Debt consolidation (where you pay off high-interest debt using a new loan)
• Life events like wedding expenses
• Home improvements to increase your home’s value
• Home repairs
• Building an emergency fund
• Paying for large medical bills

What’s Considered Taxable Income?

Taxable income is money you earn or receive which is subject to taxes — the IRS will charge you a certain rate depending on factors like how much you earn and the type of income you receive.

Taxable income typically includes:

• Salaries, wages and freelance or self-employed income
• Tips
• Bonuses
• Commissions

Some money you receive won’t count as taxable income, like child support, scholarships and certain types of government benefits.

When Do You Have To Pay Personal Loan Taxes?

Remember, the IRS doesn’t consider a personal loan taxable income, since it’s money you are borrowing and paying back. One exception is when your lender cancels or forgives your loan. In this case, the amount that’s forgiven or canceled is considered income and can be taxed.

Cancellation Of Debt (COD) Income

Cancellation of debt (COD) income is when a lender forgives or cancels all or part of your debt. That amount is now income. The amount you already paid back to your lender doesn’t count. For example, if you borrowed $15,000, paid back $6,500 and your lender canceled the rest, only $8,500 counts as taxable income.

You should receive Form 1099-C indicating the amount of debt that's been canceled. You will need to report this amount on your tax return, which will increase your overall taxable income. In turn, you may pay more in income taxes the year your debt was forgiven.

There are a few very niche exceptions where COD income may not be taxable. The amount of debt you've forgiven typically won't count as taxable income if:

• you declared bankruptcy and the loan forgiveness was part of those proceedings.
• the canceled debt was from a friend or family member and it can count as an eligible gift. In this case, you may have to file a gift tax return, especially if the amount forgiven is over the gift tax maximum.

For 2023, the gift tax limit is $17,000, and in 2024, it’s $18,000. For example, if your family member forgives $15,000 of your loan, you may not need to pay income taxes on it. However, if the forgiven amount is $18,000, some of that could count as taxable income.

Check with a reputable tax professional to see what your rights and responsibilities are.

Is Personal Loan Interest Tax Deductible?

For loans like mortgages and student loans you can deduct the interest paid, which could lower the amount of taxes you owe. Personal loan interest on the other hand typically doesn’t qualify you for any tax deductions, unless they are used to pay for qualified education expenses or purchase taxable investments. Or, if you own a business or are self-employed, and took out a loan for business uses. In this case, the interest you paid could be tax deductible.

However, these sorts of transactions can get complicated, so it's best to speak with a professional to see what you may owe in taxes.

The Bottom Line: There Can Be Personal Loan Tax Implications

Taking out a personal loan can help with many financial goals like consolidating high-interest loans and working on home renovations to increase your home’s value. If you plan your budget carefully so you can make on time payments, you won’t need to worry about any income tax on your personal loan.

But sometimes life happens and we can’t always pay back what we owe. Depending on your situation, lenders may be willing to cancel or forgive your debt, especially if you’re facing severe hardship. While it’s great you won’t have to pay that money back, the forgiven amount could count as taxable income.

If you’re thinking about taking out a loan, look at your budget carefully to see if you can afford the monthly payments. Not sure how much you spend? Consider using free apps like the Rocket Money^SM app to help you out.