Is Car Loan Interest Tax Deductible?

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Meghan Carbary has been writing professionally for nearly 20 years. A published journalist in three states, Meghan honed her skills as a feature writer and sports editor. She has now expanded her skill-set into the automotive industry as a content writer for Auto Credit Express, where she contributes to several automotive and auto finance blogs.


, - September 23, 2020

In order to make the interest on your auto loan tax deductible, it needs to qualify as a legitimate expense that can be itemized and written off when you file your taxes. This typically means claiming your car loan and vehicle as a business expense. It seems simple, but there are a lot of rules that determine whether or not you're eligible for this option.

Auto Loans as Business Expenses

You can deduct the interest paid on an auto loan as a business expense using one of two methods: the expense method or the standard mileage deduction when you file your taxes. But, writing off car loan interest as a business expense isn't as easy as just deciding you want to start itemizing your tax return when you file.

In order to qualify, you have to be self-employed and prove that you legitimately use your vehicle for business. If you use it for both business and personal use, only those expenses incurred as a result of or while on business can be tax deductible.

If you're an employee working for someone else, you can't deduct auto loan interest expenses, even if you use the car 100% for business purposes.

When you file your taxes with the Internal Revenue Service (IRS), there are many rules about what can be deducted, and how. If deducting business expenses is new for you, make sure to consult with a tax professional. It's important to think about if your vehicle can actually be considered a business expense, and make sure that it fits into one of the IRS business use categories.

Which IRS Category Does Your Car Fit In?

Experts agree that auto loan interest charges aren't inherently deductible. This is why you need to list your vehicle as a business expense if you wish to deduct the interest you're paying on a car loan. In order to do this, your vehicle needs to fit into one of these IRS categories:

  • Investment interest
  • Qualified mortgage interest
  • Student loan interest
  • Non-farm business interest
  • Farm business interest

Mortgages and home equity loans fall into a tax-deductible category, so many borrowers consider this a feasible way to make their auto loan interest deductible. If your vehicle doesn't fit into one of the above categories on its own, you may be able to write off your car loan interest charges using a home equity line of credit (HELOC) to purchase your vehicle.

However, there are some major risks involved with using a HELOC this way. If something happens and you can no longer make auto loan payments, a vehicle repossession can be dealt with. However, using a HELOC to pay your loan means you risk losing your house instead of your car. This isn't a trade-off to be made lightly.

Risks and Rewards to Auto Loan Interest Deductions

There are several instances when you can claim your vehicle on your taxes to help lower the amount of federal taxes you owe. 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 tax reduction for interest on an auto loan:

Rewards

  • High-interest loans become more affordable. If you own a small business and you 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 charges on the auto loan. If you have bad credit, you may be paying a high interest rate on the loan you used to purchase the vehicle. If you're able to deduct interest, you may be able to save hundreds or thousands of dollars on the overall cost of your car loan.
  • You owe less to Uncle Sam. Deducting auto loan interest payments on your taxes not only effectively reduces the cost of borrowing money for the vehicle, it can also reduce the amount of the check you need to send to the IRS. So, if you own a business, deducting those interest charges can help you keep needed capital in your bank account to run it.

Risks

  • You may not really be eligible. If you intend to deduct interest charges on a car loan on your tax return, you need to make sure you're eligible to do so. In most cases, you need to own a business to deduct auto loan interest. So, if you're 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 charges for car loans as a deduction on their income taxes are sometimes targeted as candidates for an audit. If you're audited, you have to provide proof of not only the validity of any deductions made, but prove you're eligible to claim the deductions to begin with.
  • You could face fines and penalties. If the IRS ever determines you're not eligible to claim car loan interest as a deduction on your income tax return, you'll 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 taxes you'd have otherwise been required to pay. In severe cases, you may face imprisonment for tax evasion – not risks many consider acceptable just to save a bit of cash on an auto loan.

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Meghan Carbary has been writing professionally for nearly 20 years. A published journalist in three states, Meghan honed her skills as a feature writer and sports editor. She has now expanded her skill-set into the automotive industry as a content writer for Auto Credit Express, where she contributes to several automotive and auto finance blogs.


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