Is Car Loan Interest Tax Deductible?

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The CarsDirect editorial team is dedicated to providing our readers with the latest on new and used cars, expert opinions on which vehicles make the grade, and all the fun stuff in between.


- June 10, 2016

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.

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.

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. Here are the main rewards and potential risks associated with claiming an IRS car tax deduction for interest paid on a car loan.

Rewards

  • High-interest 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.

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.
  • You could be audited. 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.
  • You could face 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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The CarsDirect editorial team is dedicated to providing our readers with the latest on new and used cars, expert opinions on which vehicles make the grade, and all the fun stuff in between.


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