Updated: Oct 27
Fintech has enabled the modern financial industry to evolve and grow manifold in the last decade. It has never been easier or faster to apply for a loan, get the approval, and get the money in your bank account. Perhaps that is why we see the rising popularity of personal loans among salaried and self-employed individuals.
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However, most people undermine the importance of the tax implications of borrowing. Although personal loan do not offer direct tax benefits to borrowers in India, you can avail of many underlying advantages. A critical factor in determining positive tax implications is the use of funds obtained through a personal loan.
This article is dedicated to listing down the essential factors borrowers should consider to understand the tax implications of personal loans in India –
As mentioned above, the intended use of the loan amount can entitle you to tax benefits on a personal loan. In India, if you have taken a personal loan and used the loan amount to purchase, construct, or repair your home – you can claim tax benefits on the interest paid under section 24(b). But this claim can only be submitted under prescribed limits. The aggregate interest paid on the loan can be claimed up to INR 200,000 if the house property is self-occupied. You should also be able to submit conclusive proof that the money from the loan amount was spent on such an expense.
Secondly, if you have used the personal loan amount for a let-out property – you can claim the entire interest amount on the loan against the taxable rental income. This deduction is also subject to a restriction of set-off of losses under the house property head, for all the properties taken together, against other income during the year being restricted to two lakhs. Any unabsorbed loss beyond two lakhs can be carried forward against the house property income in eight subsequent years.
Based on the purpose of the loan, your personal loan may offer a few tax benefits in India. Although you cannot use the loan's principal amount to offset any tax deductions, the interest paid towards the personal loan can be used to save taxes. If you have invested your loan amount in your business, you can show the interest paid as a business expense for tax saving. Some other situations where you can use your personal loan for tax benefits are listed below –
Investing the amount in your business
Purchasing/renovating/constructing self-occupied property
Financing a down payment on a home purchase or home renovations
Purchase of assets such as shares, jeweller, commercial property, or any other commercial endeavour wherein the interest expense increases the cost of acquisition to reduce capital gains tax on the sale.
There are no prescribed requirements to report when filing your taxes if you have availed of a personal loan and repaid it or are in the process of repaying the personal loan. If you wish to avail tax benefits on your personal loan, you should have all the requisite documents to report the borrowing and use/purpose of the loan funds. Using the loan amount to fund your business, calls for reporting similar to sales tax; using the loan amount for home construction, calls for reporting similar to property taxes. In case of a cancelled personal loan, the borrower should report it in their tax returns. The rules about discharged debt would apply here.
In most cases, you cannot get tax deductions or credits on a personal loan. However, if your loan purpose falls under the following heads, you can claim tax benefits on a personal loan.
Personal Loan for Business
If your personal loan amount is invested in your business, the interest paid on the loan amount is a business expense deducted from the taxable net profit. The Income Tax Act in India does not limit a business's tax-deductible liabilities. That means the entire interest paid on the personal loan can be used to reduce the business' tax liabilities.
Personal Loan for Purchase/Construction/Renovation of Residential Property
The Income Tax Act of India states in Section 24 that the interest paid on a personal loan taken for purchasing, constructing, or renovating residential property can be deducted from the net taxable income of the borrower. To do so, the borrower must present the proper documentation to prove the use of funds. You may claim up to INR 200,000 in deductions for a self-occupied residential property.
Personal Loan for Purchasing Assets
If the borrower uses the funds obtained from a personal loan to purchase assets like jewellery, shares, or commercial property, they cannot claim any tax relief at the time of purchase. However, the interest paid for the personal loan can be added to the cost of purchase. And you may deduct the interest paid from capital gains when selling this asset. Thus reducing your taxable profit. Here is a look at the tax credits related to this category-
Documentation and Record Keeping
It is not a mystery that loans should be well-documented. Whether the loan is taken from a bank or a private institution, documentation helps define both parties' intentions and expectations. It offers proof of the loan amount and has various benefits for the lender and borrower. Documentation is needed for accounting, taxation, collection, and loan enforcement. You should complete all the paperwork to claim tax benefits on your personal loan. Also, all the documentation and records needed to prove the purpose of your loan should be maintained for the entire loan tenure.
It is best to consult a tax professional for those with a complex income and taxation situation. Some examples are self-employed individuals with a variable income and numerous loans. Calculating your income and tax liability on your own may be difficult. Hiring an experienced tax professional will ensure your tax declaration and filing are accurate yearly. If you are not entirely aware of the tax benefits on your loan, a professional tax consultant can help you understand that, too.
Personal loans offer various benefits to borrowers, including cost, convenience, and speed of financing. Although they may not provide significant tax benefits, if you document your loan correctly and your loan purpose falls under the desired category – you can avail substantial tax benefits on the interest paid. Keep the above-listed points in mind, and always consider your loan's tax implications before you avail of it.
Q1: Are Personal Loans Taxable?
Ans: The first question many people ask is whether personal loans are considered taxable income. The answer is typically no. The IRS does not consider personal loans as income because you’re obligated to pay back the amount borrowed.
Q2: Can You Deduct Interest on Personal Loans?
Ans: While personal loans themselves are not taxable, the interest you pay on them can sometimes be deducted from your taxable income. However, this is only possible if you use the loan for specific purposes like home improvement.
Q3: Tax Implications for Non-Payment
Ans: If you default on a personal loan, and your lender forgives part or all of your debt, that forgiven amount could be considered taxable income. It’s crucial to consider this possibility when taking out a personal loan.
Q4: In the intricate tapestry of Indian tax law, what secrets lie within the utilization of personal loans for the hallowed purpose of home construction? Ans: In the mystical realm of Indian taxation, the employment of a personal loan for the sacred endeavor of home construction becomes a beacon of hope. Under the arcane Section 24(b) of the Income Tax Act, a treasure trove of tax benefits awaits. A staggering sum of INR 200,000 in deductions beckons those whose dwellings they occupy, provided the elusive proof of fund allocation for construction is presented. Q5: Can the mystical aura of tax benefits be extended to personal loans harnessed for entrepreneurial exploits in the Indian domain? Ans: Indeed, the boundaries of taxation in India expand to encompass the brave souls who venture into business endeavors with the aid of personal loans. The interest paid on this financial elixir becomes a sacred offering, diminishing the taxable net profit. The all-encompassing Income Tax Act casts no shadow of limitation upon these tax-deductible liabilities, allowing entrepreneurs to flourish. Q6: What quantum of deductions can be conjured from the depths of the tax abyss when personal loans are summoned for the acquisition, creation, or transformation of residential abodes in the Indian realm? Ans: Delving deeper into the abyss of Indian taxation, one can extract a maximum deduction of INR 200,000 from the fathomless depths. This bounty is bestowed upon those who hold the ancient scrolls of proper documentation, proving the sacred utilization of funds for purchasing, constructing, or rejuvenating their residential sanctuaries. Q7: Does the arcane world of Indian taxation impose any mystic rituals for personal loans tethered to specific purposes? Ans: Verily, the mystic rites of reporting are laid bare for personal loans in India, each tethered to its own sacred purpose. For loans christened for entrepreneurial exploits, akin to offerings to the gods of sales tax, a solemn report must be made. Should your loan be earmarked for the construction of a sacred home, the ritual mirrors that of property taxes. And in the event of a canceled personal loan, its haunting specter must be inscribed within your tax scrolls. Q8: When should one summon the wise counsel of a tax sage to decipher the cryptic runes of personal loan tax implications in the Indian realm? Ans: In the ever-twisting labyrinth of Indian income and taxation, the wise counsel of a tax sage should be summoned at the juncture of complexity. Especially those who traverse the treacherous path of self-employment, juggling multiple loans like a circus performer. The tax sage, a beacon of knowledge, shall illuminate the path, aiding in the precise calculation of income, tax liability, and the art of maximizing tax benefits intertwined with personal loans. Q9: Can the enchanting world of tax benefits be unveiled when personal loans embark on quests to acquire treasures such as jewelry or shares in the Indian expanse? Ans: While the immediate unveiling of tax benefits may elude those who tread the path of personal loans for acquiring treasures, a subtler enchantment prevails. The interest paid on the loan becomes a secret gem, subtly enhancing the cost of the treasure. Thus, when the time comes to part with these treasures, the taxable profit diminishes, rendering an indirect, yet powerful, tax boon. Q10: What sacred scrolls must be diligently preserved for tax purposes when one is entwined with a personal loan in the realm of India? Ans: To appease the tax gods, meticulous preservation of sacred scrolls is paramount. These scrolls include the covenant of loan agreements, the fragments of receipts, and the records of the sacred journey undertaken with the loan's bounty. Proper documentation is the key to unlocking the tax blessings.