Did you use a personal loan to help pay for a business-related expense?
If so, you should know that there’s a secondary benefit to this kind of loan.
Namely, the interest you pay maybe tax-deductible.
5 Important Caveats About Deducting Your Personal Loan Payments
Taking out a personal loan or even getting loans online to cover your business expenses is extremely common. Unfortunately, what’s less common is deducting the interest amount you pay on that loan from your taxes.
Before you do that, though, here are five important caveats.
1. The Principle Amount Is Nondeductible
First and foremost, you cannot deduct the total amount you borrowed. You can only deduct the interest you’re being charged as that is viewed as a business-related expense.
2. You Must Be Liable for the Debt
Make sure you have a copy of the UCC-1 financing statement (or other relevant paperwork) your lender filed. This gives notice that they have an active interest in your property.
This is to provide proof to the IRS that you are indeed legally liable for the amount you’re making interest payments on.
3. There Must Be a Debtor-Creditor Relationship
Furthermore, you need proof that you are actually making payments to your lender and proof that they’re actually depositing that money. The formal paperwork for the loan and the lender’s accounting records of deposit will suffice.
In other words, you need to reassure the IRS that you’re not just claiming to be making payments in order to write off the interest.
4. No Personal Expenses Qualify
As you can take out a personal loan for any reason you want, you may have used these funds for both business and personal reasons.
However, you can only deduct interest on the amount used for your business.
For example, if you borrowed $2,000 and spent $1,500 on repairs to your company’s equipment and the rest on repairs for your home, you can only deduct 75% of the interest you’ve been paying. The rest is for money used for personal reasons.
This also includes using the loan to fund your retirement plan or interest on amounts more than $50,000 that is taken from a life insurance policy for either the business owner or a staff member.
5. Loans for Tax Reasons Don’t Qualify
If you took out a loan to cover your overdue taxes or pay for tax-related penalties, you cannot write off the corresponding interest, even if those taxes had to do with your company.
Plan Your Deductions Carefully
Now that you understand the caveats involved, you should find it relatively easy to deduct the amounts you’re allowed from your taxes.
Nonetheless, be meticulous with your calculations. Unless it’s a straightforward situation (e.g. you took a personal loan for your business and spent the entire amount on said business), you’ll want to double-check to ensure you’re not trying to write off any money the IRS believes you are accountable for.
As long as you take that extra precaution, personal loans are great for helping your business and lowering your tax burden.