If you’ve ever done your taxes, then you know how complicated it can be. Questions like, “What do I have to claim as income?” or “Can I write off this expense?” are likely bouncing around in your mind as you frantically search the IRS’s website for answers. Unfortunately, when it comes to some big questions—like what loans you need to pay taxes on—the IRS can leave you more confused than when you started!
Luckily, we know a thing or two about loans. That’s why we’ve put together this handy guide! Read on to learn when you will and won’t need to pay taxes on loans.
In What Situations Would I Have to Pay Taxes on a Loan?
The Loan Is Not Industry Standard
Let’s say you’re about to buy your first house, and while browsing a real estate website, you spot it: your dream home. You can’t believe how lucky you are to have found it—until you see the asking price: $500,000. You know the bank can offer a $400,000 mortgage loan, but you’ll need to come up with that last $100,000 on your own. If your family is financially able, they might agree to lend you that remaining amount. But before any funds change hands, you need to be aware of the strict tax regulations that govern intrafamily loans.
The Internal Revenue Service (IRS) requires that long-term (i.e., a pay-back period of nine years or more) intrafamily loans must have a minimum rate of 1.15%. Midterm loans of three to nine years come with a rate of 0.58%, and short-term (i.e., three years or less) loan rates are 0.25%. If your family member doesn’t charge you interest and doesn’t file a gift tax form, you may be on the hook for the interest they should have charged you.
The Loan Was Forgiven
When a lender cancels your loan debt for one reason or another and stops trying to collect from you, they will send you what is known as Form 1099-C, showing you the amount of debt they canceled. In the eyes of the IRS, however, the forgiven amount now qualifies as income. This is because, when you took out a loan—whether it be a student loan, personal loan, mortgage loan, home equity loan, etc.—you borrowed money and agreed to pay it back. In other words, you don’t financially gain from the loan. However, when you no longer have to repay a loan, that money is now classified as cancellation of debt (COD) income, on which you can be taxed.
Examples of COD that are characterized as taxable income includes debts such as:
- Credit card debt settlements
- Settlements of $600 or more
- Pay-offs negotiated with collections agencies
- A short sale on a physical property
When Would I Not Need to Pay Taxes on a Loan?
The Loan Is Forgiven Due to Special Circumstances
Several special circumstances can cause a loan to be forgiven without it being taxable. For instance, your student loans can be forgiven if the student goes into and works for some time in specific professions for a wide range of employers, such as nursing or teaching.
Additionally, if you were insolvent (meaning your debts were more than the value of your assets) before your creditor forgave your debt, then you do not have to pay taxes on the COD income. For a more thorough explanation of exemptions, check out this article.
You Pay Back the Loan as Scheduled
If you pay off the loan’s full amount plus interest in the allotted time, great news! You are not required to pay taxes on the loan.
Taxes Can Be Complicated…
…but getting a personal loan shouldn’t be! That’s why we make it easy to apply online to check your offers with no effect to credit score. You could get approved as soon as today with funding in as little as 24 hours!