Can You Deduct Interest Paid on a Car Loan?

Paying interest on a car loan can be a significant expense for many taxpayers. With the average new car loan interest rate around 6%, borrowers pay thousands in interest over the life of a 5-6 year loan. This leads many car owners to wonder – can I deduct the interest I pay on my car loan when I file my taxes?

The answer unfortunately is usually no. Personal car loan interest is not tax deductible for most taxpayers. However, there are some cases where you may be able to deduct a portion of the interest paid on a car loan.

When Car Loan Interest is Deductible

The only scenario where car loan interest can be deducted is when the vehicle is used for business purposes If you use your car for your job or business, you may be able to deduct a percentage of the interest paid

Specifically, these are the main situations where deducting car loan interest is allowed:

• Self-Employed Small Business Use: If you are self-employed and use your car primarily for business purposes, you can likely deduct a portion of the interest. This includes rideshare drivers, delivery drivers, real estate agents, consultants, and other self-employed professionals that use a car for work.

• Business Use by an Employee: If you are an employee who uses your own car for work duties, you may also deduct a percentage of the interest. For example, a sales rep who drives to meet clients may qualify.

• Business-Only Use: If you purchased the car solely for business use and do not use it for personal reasons, you can deduct all the interest paid. This is less common, as most business owners use their car for both personal and professional driving.

• Farming, Rental Properties, or Royalties: Interest paid on a car loan can also be deducted if the vehicle is used for income related to farming, rentals, royalties, or similar activities.

The key in each scenario is proving the car is used regularly and primarily for business or income-generating purposes. Purely personal use does not qualify for deducting interest paid.

How Much Interest Can You Deduct?

If you use your car for both business and personal driving, then only a percentage of the interest paid is deductible. The amount depends on your business use percentage.

For example:

• You pay $1,000 in car loan interest for the year
• You use your car 40% of the time for business purposes
• You can deduct 40% of $1,000, or $400, as a business expense

To determine your business use percentage, keep track of total business miles driven versus total personal miles for the year.

If your car is used 100% for business with no personal driving, you can deduct 100% of the interest paid. This maximizes the potential tax deduction.

Claiming the Tax Deduction

To properly claim your deductible car loan interest, be sure to follow IRS rules and retain documentation. Here are some tips:

• Track your mileage in a log or app to confirm business vs personal use
• Keep detailed records of interest paid on your car loan statements
• Claim the deduction on Schedule C for self-employed filers
• Prorate the interest based on business use percentage
• Keep paperwork for at least 3 years in case of an audit

It’s wise to consult a tax professional if you have questions. They can review your situation and ensure you calculate deductions accurately.

Limitations and Exclusions

While deducting car loan interest can provide some tax savings, there are limitations:

• Commuting mileage is not considered business driving
• You cannot deduct interest if the car is for personal use only
• Carpooling or driving others is not business use
• An employee driving to an office is not business use

In addition, you cannot deduct other car expenses like gas, maintenance, parking fees, insurance and more. Only the interest portion is deductible.

For employees, there are extra rules imposed by the Tax Cuts and Jobs Act of 2017. This includes restrictions on business use deductions for employees. Be sure to consult a tax expert to ensure you qualify.

Is It Worth Claiming the Deduction?

Claiming car loan interest requires extensive mileage tracking and record keeping. You need to calculate the proper business use percentage and prorate expenses correctly.

For filers with minimal business mileage, the potential tax deduction may not be worth the effort required. Track your mileage for a few months to see if your business use is significant. For less than 50% business use, skip the deduction.

You also need enough total interest paid to make it count. With an average car loan rate around 6%, you would need to pay at least $5,000-$6,000 in total interest to get a sizable deduction. If your loan amount or rate is low, there may not be enough interest paid to benefit.

Alternatives to Deducting Interest

If you cannot deduct your car loan interest, there are other options to save on taxes:

• Standard Mileage Deduction: You can deduct 58.5 cents per business mile driven instead of actual expenses. This is easier but results in a lower deduction for high mileage drivers.

• Section 179 Deduction: If you purchased the car for business, you may qualify to deduct up to $1 million thanks to Section 179. This allows deducting the full purchase price in the first year.

• Business Use Deductions: You can deduct business-use portion of gas, maintenance, insurance, etc. This requires detailed tracking but can provide substantial write-offs.

• Lease Payments: If you lease instead of finance, the business-use portion of your monthly payments is deductible. There is no interest with a lease, but the principal can be deducted.

So while deducting interest on a car loan has limitations, you still have options to maximize tax write-offs as a business owner. Be sure to consult with a tax professional to utilize all available deductions and reduce your taxable income. With the right approach, you can reap significant savings each tax season.