Can You Deduct Car Loan Interest on Your Taxes?

Taking out a car loan is often necessary to purchase a new or used vehicle. While making those monthly payments, you may wonder if the interest portion can be deducted on your taxes. In some cases, self-employed taxpayers and small business owners can write off auto loan interest. However, there are specific requirements that must be met.

This guide will cover when car loan interest is tax deductible, how to calculate the deduction, documentation needed, and common mistakes to avoid when claiming the deduction.

Overview of Deducting Car Loan Interest

When filing your taxes each year, any interest paid on personal loans, auto loans, and credit cards is generally not tax deductible These are considered personal expenses.

However, there is an exception if you used the loan proceeds specifically for legitimate business purposes The interest may qualify as a business expense deduction

Some key things to know:

• Vehicle must be used for business, not just personal use

• Only the portion of interest tied directly to business use percent can be deducted

• Thorough records must be kept to back up the deduction

• Applies to self-employed taxpayers and business owners

• Employees cannot deduct auto loan interest for a work vehicle

Deducing car loan interest provides small savings on your tax bill. But documentation and calculating the deductible amount can be complex.

Requirements for Claiming the Deduction

To qualify for deducting auto loan interest, you must meet these IRS requirements:

• You are self-employed or a business owner, not an employee

• The vehicle is used for your trade or business

• If used for both business and personal, you can only deduct the business use percentage

• You are legally obligated to make the interest payments

• You itemize deductions on Schedule C (self-employed) or Schedule F (farmers)

Without a clear business purpose, the IRS will disallow the deduction. Note that commuting and driving to your regular workplace does not count as business use.

How to Calculate the Deductible Amount

Figuring out what portion of auto loan interest you can write off takes some work. Here are the steps:

1. Track business vs personal mileage for the year – Document this in a log or use total annual odometer readings.

2. Determine the percentage of business use – Divide business miles by total miles.

3. Calculate total auto loan interest paid for the year – Find on 1098 form from lender.

4. Determine the deductible amount – Multiple the business use percent by the total interest.

For example:

• Total miles driven: 15,000
• Business miles: 7,500
• Business use percent: 7,500 / 15,000 = 50%
• Total interest paid: $1,200
• Deductible amount: $1,200 x 50% = $600

Keep accurate mileage logs and interest payment records as the IRS may request them if audited.

What Documentation Should You Keep?

Thorough records are crucial to validate your deduction and avoid issues with the IRS. Documents to retain include:

• Auto loan statement or 1098 form showing interest paid for the year

• Mileage log documenting dates, business purpose, and odometer readings

• Receipts for gas, repairs, maintenance, and other vehicle expenses

• Evidence the vehicle is used for business such as client invoices or 1099 forms

• Business percentage calculation and how deductible amount was determined

Keep records for at least 3 years after filing per IRS guidelines. Lacking documentation may lead to deduction denial.

Common Mistakes to Avoid

When claiming the car loan interest deduction, watch out for these common errors:

• Deducting 100% of interest for a vehicle used partially for personal purposes

• Failing to accurately track business vs. total mileage

• Not keeping detailed logs and records to support the deduction

• Claiming the deduction as a W-2 employee for a company car

• Forgetting to itemize deductions on Schedule C or F

• Disposing of records too soon in case of an audit

Consult a tax professional if you have any uncertainty. Make sure you qualify before claiming the deduction.

The Bottom Line

Deducting auto loan interest on a vehicle used for your small business or self-employment income can provide modest tax savings each year. But be sure to follow the IRS requirements closely and maintain sufficient documentation. Work with an accountant or tax advisor if needed to ensure you calculate the deduction accurately based on your specific situation. With good records, the interest deduction can be a nice extra tax break as a business owner.