A:

Interest paid on personal loans is not tax deductible. If you take out a loan to buy a car for personal use or to cover other personal expenses, the interest you pay on that loan does not reduce your tax liability as do other interest payments. Similarly, interest paid on credit card balances is also not tax deductible.

Debt Expenses That Can Be Deducted

Though personal loans are not tax deductible, other types of loans are tax deductible. Interest paid on mortgages, student loans and business loans can be deducted on your annual taxes, effectively reducing your taxable income for the year.

However, certain criteria must be met to qualify for the above deductions. For example, mortgage interest is only deductible if the loan was taken out to fund the purchase of a primary or secondary residence. You may be able to claim a tax credit, which directly reduces the amount of tax you owe rather than your taxable income, for mortgage interest if you were issued a mortgage credit certificate through a government program for low-income housing.

Exception to the Rule

If you use a personal loan or credit card to finance business expenses in addition to personal expenditures, you may be able to claim the interest paid on those expenses on your taxes. You must be the person legally liable for the loan, and you must be able to itemize what portion of the interest paid is attributable to legitimate business expenses.

Similarly, if you use a personal loan to purchase a vehicle that you use for business purposes, then some or all of the interest on the loan is tax deductible. If you use the vehicle solely for business, then all of the interest is deductible. If you use it for both personal and business purposes, then you can deduct loan interest proportionate to the amount of time you use the vehicle for business. If you spend 60% of your driving time on business errands, then 60% of the annual interest is deductible.

This exception also applies to the use of a personal loan to invest in an S corporation, partnership or limited liability corporation (LLC). However, the rules governing these deductions are complicated so it is wise to enlist the aid of a qualified tax professional.

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