Is Car Loan Interest Tax Deductible?

February 24, 2014

Financial experts have long recommended claiming car loan interest when filling out taxes, but is car loan interest tax deductible? Get the facts.

As with many things involving the Internal Revenue Service, there is not a straight yes or no answer to the question, "Is car loan interest tax deductible?"

Prospective car buyers looking for a way to make auto loan payment interest tax-deductible have to find a way to fit it into one of the categories below. One of the most common ways to do this is to detail the auto line as a business expense. When doing this, the usual standards apply: the driver should think carefully about what constitutes a business expense, and whether the use of this vehicle applies to a business use category.

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IRS Categories

The Internal Revenue Service and financial experts have provided some categories for tax-deductible interest including the following: mortgage or home equity payments, student loan payments, business loan payments, and payments for specific types of personal loans. Many accounting experts agree that an auto loan is not inherently tax-deductible on an individual's federal tax return.

Another way to place a loan into a tax-deductible category is to use a home equity loan or HELOC (home equity line of credit) to finance the purchase of a vehicle. Because mortgage and home equity loan interest is included in a tax-deductible category, this is a popular way to place an auto loan under the "umbrella" of what is considered to be deductible.

However, there is a downside to pursuing a home-equity-based approach to an auto loan. Someone who is borrowing for an auto loan should know that in the case of securing the loan with home equity, the property will be the first asset on the firing line in the case of nonpayment. Without this in mind, a borrower can fall prey to replacing the simple repossession of the vehicle with a liability involving their primary investment: the home.

Financial Experts
Although financial experts will tell you that these are the main options for making auto loan interest payments tax-deductible, there are many rumors circulating about new rules under a US tax stimulus plan that would change Internal Revenue Service regulations to make auto loan interest payments tax-deductible to also make tax-deductible the amounts paid in auto sales tax upon purchasing a vehicle. The reasoning behind this, according to many of those reporting on the situation, is that the large auto companies which are now under considerable distress need customers in order to make themselves viable again. Recent economic events have shown how interdependent American businesses are, and how government and business can work together to minimize economic damage in a down market. With that in mind, auto buyers can anticipate potential relief from new government legislation that may help those without property assets deducted auto loan interest payments from their income tax returns.

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Risks and Rewards of Claiming Car Loan Interest with IRS Car Tax

There may be times you can claim IRS car tax deductions for interest paid on a car loan to help lower the amount of Federal taxes you owe. Car loan interest can add thousands of dollars to the price of a new car or truck. So, being able to deduct the interest on your taxes can help reduce the overall cost of ownership. However, while these deductions can be tempting, they don't come without risks. So, here is a list of the rewards and potential risks associated with claiming an IRS car tax deduction for interest paid on a car loan.

The Rewards

High interest car loans become more affordable. If you own a small business, and frequently use your vehicle in the operation of that business, then you can deduct almost all types of expenses for driving and maintaining your car or truck. This includes interest on the car loan.

If you don't have perfect credit history, you may be paying a very high interest rate on the loan you used to purchase the vehicle. Therefore, interest payments on high rate car loans can add up to thousands of dollars. Being able to deduct the interest on your federal income tax return can significantly reduce the cost of borrowing money to purchase a vehicle.

You owe less to Uncle Sam. Deducting car loan interest payments on your taxes not only effectively reduces the cost of borrowing money for the vehicle, it also can help reduce the amount of the check you need to send into the Internal Revenue Service. So, if you own a business, deducting those interest charges can help you keep needed capital in your bank account to run your business.

The Risks

You may not really be eligible. If you intend to deduct interest payments on a car loan on your tax return, you need to make sure you're really eligible to do so. In most cases, you need to own a bona fide business to deduct car loan interest payments as deductible expenses. So, if you are a subcontractor, or work for yourself without a proper business license, you may not be able to legally claim the deductions at all.

Could make you a target for an audit. Taxpayers that claim interest payments for car loans as a deduction on their income taxes are frequently targeted as candidates for an audit. If you are selected for an audit, you will have to provide proof of not only the validity of any deductions made, but prove you are eligible to claim the deductions to begin with.

Could result in fines and penalties. If the IRS ever determines you are not eligible to claim car loan interest as a deduction on your income tax return, you will probably be penalized quite severely. In fact, you may have to pay hefty fines and penalties that could double, or even triple the amount of tax you would otherwise have been required to pay. In severe cases, you may face imprisonment for tax evasion.

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How to Report Car Loan interest on a 1040 Tax Form

Car loan interest on 1040 is a method that allows for the owners of cars to pay the interest of their car loans from their taxable income. The specifications and the eligibility criterion are pretty strict, and many times people need to come back dejected. Though, it is still worth a try. If it comes through, it helps reduce the overall burden of the purchase, thus providing a boost to the auto industry in terms of the sales they generate. However, this is possible only in specific cases and not available to all.

Requirements

  • IRS Schedule C
  • IRS Schedule A
  • Mileage Log of the Vehicle
  • Vehicle Loan Interest Statement

Checking or Identification
The interest amount is liable to be deducted from the total taxable amount, only if the corresponding loan has been taken for investment. People with personal loans are not eligible for such compensations. As far as the car loan payments are concerned, if it has been brought for personal use, it will not be processed and the taxable amount would not reduce. However, if the car is driven for business purposes, the total interest in proportion to the number of miles driven can be mentioned.

Schedule A
This schedule is used to list all the deductions applicable. All the interest expenses that require to be deducted from the taxable amounts need to be mentioned in a sequence. Step by step instructions are mentioned on Form 4952 to assist the tax payers in calculating the total amounts. Check the other instructions, if any, to determine further amendments. Deductions in qualifying loans are also possible for certain people.

Schedule C
This schedule allows mentioning the total miles driven in the car for business purposes. All figures corresponding to the total driven miles should be in percentage. The total amount payable is the multiplication of the percentage for which the car has been utilized for business use, times the total interest paid for the vehicle. To understand better, consider an example. If by computing the car loan interest rate, the total interest that needs to be paid is $1000 and the car has been driven for a total of 10,000 miles, of which 2,000 are for business purposes. The percentage is equal to (2000/10,000) * 100 = 20%. Hence, the total deductable amount would be 20% of 1000 = $200.

Precautions
Remember to take all the supporting documents and the form duly filled out, as it is liable for rejection in case of errors. Place the figures in the correct lines and tick the appropriate boxes. Make sure the form is for the current year. A tax professional would be able to provide better correspondence on the basis of the individual's needs and conditions.

Both the forms have different purposes and are applicable in different scenarios. The schedule A is applicable if the car has been brought for office use only, whereas the schedule C is when it is a personal car (not qualifying for schedule A) but is being used for business purposes as well.

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