Personal Loans – What Tax Considerations Should You Be Aware Of?

If you have a good income, there may come a time when you want to lend money privately. For example, you might want to help a friend financially or offer your personal savings through a lending platform to earn interest. Whether you lend money to a friend or a stranger, it is always considered a private loan as soon as interest is charged. Interest is income and is therefore subject to taxation. In this article, we will therefore explain what you need to consider regarding taxes when it comes to private loans.

What is a private loan?

Traditionally, loans are granted by banks, i.e., a legal entity. With a private loan, you, as a natural person, are the lender. Such a loan is often given to family or friends because a bank may not be willing to approve the corresponding credit line. It is also important to draw up a contract for private loans. The contract should specify the loan amount and the interest to be paid. It should also set the timeframe within which the loan is to be repaid. With a solid contract, you can avoid unnecessary disputes and provide proof to the tax authorities of the agreements that were made (this is particularly important with regard to tax reporting requirements).

In recent years, platforms have also emerged that make it possible to grant private loans to “strangers.” These lending portals serve as a meeting place for lenders and borrowers. Private loans are sometimes seen as an alternative to other investments. Depending on the loan amount and the terms of the agreement, you can earn a good return on the interest.

What must private lenders pay taxes on?

Taxes must always be paid whenever someone increases their earning capacity, i.e., earns money. If interest is paid on a loan, this constitutes income. Income in the form of interest must therefore be reported on the income tax return.

Interest income is classified as “income from capital assets.” All such income must be reported in Schedule KAP. In most cases, the interest collected over the course of a year is taxed at a flat rate of 25% plus a 5.5% solidarity surcharge. Church tax may also apply. For private lenders who lend only a small amount, no taxes may be due if the tax-free allowance of 801 euros is not exceeded.

As a private lender, you should therefore keep in mind that all loans bearing interest are subject to taxation. It does not matter whether the borrower is a close friend or was found through a platform. Depending on the amount lent to a friend or family member, it is questionable whether interest is always necessary or desired. If no interest is charged, the private loan is not relevant for tax purposes. You can therefore continue to help out with small sums without reporting this to the tax authorities.

Hiding Interest Income on Your Tax Return – What Happens?

Of course, one might wonder how the tax office would find out about a private loan and the interest associated with it. So, at least when it comes to loans to friends and family, you could just let the interest income slide under the table, right? If you grant a loan to a friend and they pay you interest in return, this doesn’t necessarily have to be noticed right away. However, it becomes problematic if the borrower claims the interest paid as income-related expenses on their tax return. This is how the tax office becomes aware of the situation and may notice the missing income in your tax return. Once the tax fraud is detected, you will of course face a major problem, as you will then be accused of tax evasion. As tax advisors in Düsseldorf, we therefore strongly advise against such practices.

Legal and Tax Advice for Private Loans

Lending money to a good friend usually doesn’t require extensive planning. However, as soon as a private loan is granted for an extended period and involves large sums of money, you should seek legal and tax advice. There are various legal and tax pitfalls that you should avoid as much as possible. We therefore recommend a consultation with a financial expert and tax advisor.

With our offices in Düsseldorf and Oberhausen, we are the ideal partner for tax-related questions and issues. Our team of qualified professionals will assist you promptly and with a high level of expertise. Simply contact us to schedule a consultation.