Tax Implications On Personal Loans: Things Borrowers Should Know

A personal loan can be a lifeline for individuals who need immediate liquidity. Typically, individuals need liquidity in case of emergencies, to undertake home improvement, or to consolidate their debts. While a personal loan is not considered as taxable income, there are some differences between the old and the new tax regime for the taxation of interest on such loans as well as on their usage. These changes are aimed at helping the borrower in making informed decisions and reducing their tax liability. 

How Are Personal Loans Taxed? 

A personal loan by itself is not treated as taxable income. Since a debt has to be repaid, it cannot be treated as income for tax purposes. Thus, borrowers do not need to report the loan amount credited in their account. However, the loan amount can have tax implications based on the purpose for which the borrowed amount is used. For instance, if the money borrowed is used for a purpose which is eligible for tax deductions, the borrower can claim tax benefits under various sections of the Income-tax Act, 1961. 

Tax Benefits On Personal Loan 

There are direct tax deductions which are applicable on interest on home or education loans under the Income-tax Act, 1961. However, unlike home loans or education loans, direct tax deduction is not applicable on personal loans. Though personal loans can be borrowed for a variety of reasons, the following sections of expenses can be deducted: 

Home Purchase, Construction, or Renovation: If a personal loan is used for purchasing, constructing, or renovating a residential property, the interest paid on the loan can be claimed as a deduction under Section 24(b) of the Income-tax Act, 1961. The maximum deduction allowed is Rs 2 lakh per year for self-occupied properties under the old tax regime. For let-out properties, the cap does not apply on interest deduction, but the total loss from house property that can be set off against other income, which is limited to Rs 2 lakh per year. The deduction is not available under the new tax regime. 
 

Business Use: If the amount borrowed by way of a personal loan is used for business purposes, then section 37(1) allows taxpayers to show the interest paid as a business expense. This provision is available under both the new and the old tax regimes.  

Investment In Assets: If the loan is used for acquiring assets, such as stocks, jewellery, or other capital assets, the cost of interest can be added to the acquisition cost. This can potentially reduce the capital gains when such an asset is sold sometime later. Taxpayers can use this provision under both the tax regimes, however, the reduction can only be claimed when the asset is sold. 

Comparison Of Implications Under The Old And New Tax Regimes 

Under the old tax regime, personal loans taken for home purchase, construction, or renovation are allowed as deductions under Section 24(b), which is capped at Rs 2 lakh per year for self-occupied properties. In contrast, under the new tax regime, home loan interest on self-occupied or let-out properties cannot be claimed as a deduction. However, interest paid for business purposes and asset acquisitions is still deductible under the new regime. 

The old tax regime provides multiple deductions and exemptions, making it more beneficial for those with high tax-saving expenses, including home loan interest payments. If you have a personal loan being used for property renovation or business purposes, the old regime may help you reduce your taxable income. 

The new tax regime introduced in FY 2020-21 provides lower tax rates, but removes most exemptions and deductions. Therefore, the new regime will be more straightforward and beneficial for taxpayers who do not have significant deductions to claim. 

Things to Keep in Mind While Taking a Personal Loan 

Purpose of Borrowing: Personal loans do not provide tax benefits, but if they are borrowed for home renovation, business, or asset acquisition, taxpayers can reduce their tax liabilities. 

Proper Documentation: You will require receipts and proof of loan utilisation to claim tax benefits on your personal loan. 

Compare Your Tax Options: If you have deductions under Section 24(b) or business expenses, the old tax regime might be more beneficial for you. 

Check Loan Interest Rates: While tax deductions can help, a high-interest personal loan may still increase the overall financial burden. 

Personal loans provide financial flexibility, and using them strategically for home renovations, business investments, or asset purchases can help in reducing one’s overall tax burden by allowing one to claim deductions under the old tax regime. 
 

Understanding how tax applies on your personal loan can help you in planning your finances better. However, individuals should consult a tax expert to evaluate which is the best strategy for them based on their financial situation.