Tax Benefits of Personal Loans: Unlock Hidden Savings

Quick loans are common these days. With instant personal loan platforms available today, this trend is gaining momentum every day. Personal loans are unsecured and can be availed of easily. This is why a larger number of borrowers find themselves going for these loans to procure funds for their personal needs. These requirements may include wedding, vacation, education expenses or other personal projects.

Personal loans are a quick way to arrange funds. However, it is important to find a lender with affordable interest rates. In this context, tax deductions on personal loans are a much-needed benefit for borrowers. But the most important question here is, are personal loans taxable?

Does India’s Income-tax Act (ITA) Allow Tax Deductions on Personal Loans?

• The principal amount of the loan
• The interest charged on the loan

When we talk about the personal loan tax deduction, there are two aspects of any loan. Each aspect is tackled differently by India’s income-tax act in terms of tax benefits. These two aspects are: 

If one is to answer the question about the possibilities of a tax rebate on personal loan the simple answer would be “No.”

The Income-tax Act of India has rules for tax deductions and exemptions on both the principal and interest of certain loans. These include home loans, education loans, business loans etc. But the act does not entertain any tax deductions on income tax returns in case of personal loans. 

The end-use of loan money will decide whether tax should be levied on a personal loan or not. This is due to the lack of direct mention of tax relaxations on personal loans interest rate and principal in the income-tax act.

Another key factor here is the source of your loan be it a traditional source or an instant personal loan app. The principal of a personal loan can become taxable or non-taxable, depending on the source from which you acquire the loan.

Suppose you are taking a personal loan from a bank, NBFCs or other legally approved financial institution. In that case your loan’s principal amount is considered a liability and is not taxable.

The rule is the same if you apply for personal loans online using an instant loan app. However, if the amount is borrowed from a friend, relative or other non-professional lending sources, it is viewed as your income. Such income is added to your gross income at the time of income-tax calculations.

But what about the interest paid on personal loans? Can a borrower enjoy tax deductions on the personal loan interest? As discussed above, there a re certain conditions and the final use of the loan money that will be considered for any tax relaxation.

Here are three circumstances under which a person can avail of tax benefits on a personal loan:

1. Personal Loan Used for Business

If a borrower ends up investing the personal cash loan in his business the interest on that loan becomes a liability for that business. Here, the interest paid is considered an expense and can be deducted from the net profit of the business. This brings down the total amount of taxable net profit. Furthermore, the income-tax act has set any limit on the amount of tax-deductible liabilities of a business. This means that the entire interest on the person can be tax deductible if used in business.

2. Personal Loan Used for Buying or Construction of a Residential Property

Section 24 of the Income Tax Act, titled “Deductions from Income from House Property”, makes it possible to enjoy tax benefits. According to Section 24, interest paid for funds acquired through a personal loan can be deducted from the net taxable income from residential property. Section 24 will apply if the money is used for purchasing, constructing or renovating the same property. 

Since section 24 of ITA does not specify the type of loan, personal loans are also eligible for said tax deductions. The borrower would need to present the required documents to prove the use of personal loan money. Up to ₹2 lacs can be claimed as tax deductions on the interest of a personal loan if the borrower occupies the house

3. For Purchasing Assets

Suppose the borrowed funds are used for acquiring jewellery, shares or any other non-residential assets. In that case the borrower cannot claim any immediate tax relaxation at the time of purchasing said assets. However, the interest paid on loaned money used for buying the asset is added to the total cost of acquiring that asset. Therefore if the borrower ever sells a particular asset, the paid interest is also deducted from the capital gains. It is cut as part of the acquisition cost. This will effectively reduce the taxable profit.

Wrapping Up

Instant personal apps like Fibe have provided easy access to fast personal loans. The income-tax act of India does not explicitly provide any guidelines on taxes on personal loan. This vagueness allows other ways to ascertain tax benefits on personal loan. Tax benefits on personal loans can only be availed if borrowers fulfil certain eligibility criteria. This can be proved by presenting the necessary documents. So it is very crucial to keep safe all documents, bills and certificates relevant to the loan or the use of loaned funds.

FAQs on tax benefits on a Personal Loan

How do I claim tax benefits on a personal loan?

While there are no tax benefits on a personal loan as such, you can claim tax exemption on the interest paid. This depends on the end usage of your personal loan amount. Here are the 3 instances which can help you in claiming tax benefits on your personal loan:

• If you are using the loan amount to expand your business
• If you buy, construct or renovate a residential property using the loan amount
• If you are investing the amount to purchase fixed assets such as vehicles

Is there any tax benefit on a personal loan?

A personal loan is not taxable and usually doesn’t offer any exemptions. However, based on how you use the loan amount, you can get deductions on the interest you pay on the personal loan.

How do I show a personal loan on my tax return?

As a personal loan does not qualify as income, there is no need to show it on your tax returns. The money you earn from investments or jobs is classified as taxable income. Since you have to repay a personal loan, this need not be included in your tax returns.

Can I claim tax relief on personal loan interest?

Yes, there are tax deductions on personal loan interest if the funds are used to renovate or purchase a piece of property as stated in section 24 of the Income Tax Act.

Which loans are eligible for tax exemption?

Along with personal loans for certain expenses, education, home and business loans are also eligible for tax exemptions.

How do I get a loan on my income tax return?

You can get a personal loan with your ITR as income proof. All you need to do is submit your ITR copies at the time of application. Be sure to check with the lender to confirm if ITR is an accepted proof for your application.

Can I use my tax return for a loan?

Yes, depending on the lender, you can submit your ITR as valid income proof to avail of a personal loan.