Tax consequences of borrowing money
Taking out a loan is a financial transaction that can have tax consequences. This is not always the case, but it is possible. The possible tax consequences are:
- Less load in box 3
- 2. deductible interest in box 1
1. Less tax in box 3
In principle, a consumer credit such as a personal loan or a revolving credit falls in box 3, which is the tax box in which tax is levied on capital. Now a loan is not a possession, it is a debt. A loan, therefore, lowers your capital in box 3, with the effect that you pay less tax on your capital.
This does not have consequences for everyone. To pay less tax in box 3 you first have to pay tax. After all, less than zero is not possible. You only pay tax in box 3 (capital gains tax) if you have more capital in 2020 than the exempt amount of $ 30,846 per person ($ 30,360 in 2019). This only applies to partners with assets of more than $ 60,000. If the total value of your savings, investments, etc. is less than that, then you already pay no tax in box 3.
If you are above the exemption, a loan can, therefore, reduce the tax payable. The loan must, however, exceed the debt threshold. That threshold is to prevent any overdraft on a payment account from causing tax hassle.
2. Deductible interest in box 1
In some situations, the interest you pay on a loan is tax-deductible through the mortgage interest deduction. This is only possible if the loan meets certain conditions. The first condition is that the borrowed money is spent on the purchase, maintenance or improvement of an owner-occupied home. For example, a loan for a renovation. Or for a new kitchen. Or for a dormer. For these spending goals, the loan falls under the home acquisition debt, which does not require that it be a mortgage.
The second condition for mortgage interest deduction is that the loan is repaid at least annually in a maximum of 30 years, according to a set schedule. A revolving credit does not meet that condition. A personal loan does.
So if you have taken out a personal loan for renovating your own home, the interest on that loan is tax-deductible. The loan then falls in box 1 instead of inbox 3.
If you are going to renovate and want to borrow money for it, it is wise to find out what is cheaper: increase the mortgage or take out a personal loan. All kinds of costs are involved in increasing a mortgage. These are not an issue when taking out a personal loan. However, the interest on a personal loan is higher than on a mortgage. Which choice is better in your situation? For this, you have to compare the cost advantage of the personal loan with the interest benefit of the mortgage.