Car owners are always looking for ways to save money on their vehicles. One way to do that is by claiming tax deductions wherever relevant! If you’ve ever wondered if car loan interest is tax-deductible, this post will tell you everything you need to know.
Despite car loans being secured loans (the vehicle is the collateral), the APRs charged them can be quite high. Car owners are always on the lookout to save money – to the extent that many Americans often wonder whether they can write off any car loan interest charges when filing taxes.
Short answer: You will be able to deduct car loan interest from your tax returns only if you own a car for business purposes. If you’re self-employed, you will be able to write off a portion of your interest payment – depending on how much you use the car for your business.
What is auto loan interest?
The interest on your car loan is the cost of borrowing money from a certain lender for a car loan, personal loan, mortgage, etc. When you repay the loan in monthly installments, a part of it goes towards repaying the interest, while the other part goes towards the principal.
Is car loan interest tax-deductible?
For regular taxpayers, deducting car loan interest is not allowed. However, it is possible for taxpayers who meet certain criteria.
When car loan interest is deductible
1. You can write off a part of your car loan interest if you bought a car for personal use but ALSO use it for business purposes. For example, let’s imagine that you are a business owner, freelancer, gig worker, or self-employed contractor. Even if you bought the car for personal use, you will be using it for certain car-related business expenses (like transportation of goods, business errands, work trips). These expenses can be written off from the car loan interest that you pay every month.
However, you can only claim tax deductions for business purposes and not when you used the car for personal reasons. For example, if 70% of your car use was for business and 30% for personal affairs, then you can only deduct 70% of the car loan interest from your tax returns.
2. You can write off up to 100% of your car loan interest if you bought a car solely for business purposes.
When car loan interest is not tax-deductible
If you took out a car loan to purchase a vehicle for commuting and personal use only, then the car loan interest on it is not tax-deductible.
What kinds of interest are tax-deductible?
According to the Internal Revenue Service (IRS), five types of interest are deductible on an income tax return.
- Farm business interest
- Non-farm business interest
- Student loan interest
- Investment interest
- Qualified mortgage interest
Until 2017, you could also get tax write-offs for interest paid on home equity lines of credit (HELOC) that were used to purchase vehicles. However, this was suspended until 2026 by the Tax Cuts and Jobs Act 2017.
How can you write off car loan interest?
The IRS allows you to calculate your tax deductibles based on two different methods:
Actual Expenses Method
This allows you to deduct all eligible car expenses that you rack up in a financial year. You need to add up all the expenses on the car during the year and multiply it by the percentage of business use.
- For example, if your total car expenses during a year were $8,000 and you used the vehicle for business purposes 40% of the time, then the amount you spend on business expenses is 40% * 8000= $3200. This will be your tax-deductible amount.
The costs you can include as part of the Actual Expenses Method include:
- Lease payments
- Insurance premiums
- Depreciation costs
- Maintenance charges (oil changes, brake fluid, brake pads)
- Tolls and parking fees
- Title, licensing, and registration fees (in certain states)
Standard Mileage Rate Method
This method involves keeping track of the number of miles you drive in a year and multiplying that with a standard cost per mile. The IRS keeps updating the standard mileage rate – and as of 2022, it is 62.5 cents per mile or 0.625 dollars per mile
The Standard Mileage Rate includes several of the costs you would normally add up as “actual expenses” – like maintenance, gas, oil, repairs, etc. Multiplying this rate with the number of miles covered for business activities will give you a deductible amount on your tax return.
- For example, if you drove 10,000 miles in a year and half of that was for business (5000 miles), then your tax write-off will be 5000 * 0.625 = $3125.
What documents do you need to claim car loan interest tax deductions?
It is helpful to keep thorough records and paperwork regarding your business expenses. This will make it easier to claim tax deductions and can help the authorities verify the claim as well. Save these documents for 3-4 years in case you ever need to refer to them in the future.
- Have a record of all the car loan payments you have made so far and how much of the interest you have repaid.
- Keep a record of all journeys made in the car for business activities
- Keep a mileage log to track the distance traveled for work-related errands
- You can also keep parking and toll receipts to validate your claims, even if they are not a part of the final deductible amount.
Pros and cons of auto loan interest tax deduction
Benefits
- Helps you afford high-interest loans: Interest charges on vehicle loans are often the costliest part of borrowing. Getting a deduction can take the edge off a high-APR car loan.
- Reduces the cost of borrowing: Small business owners can access better loans.
- Making the best use of finances: With more Americans getting into debt every day, it’s important to maintain control over your finances and get back as many refunds as you can.
Drawbacks
- Need to confirm if you are eligible: Ensure you have a proper business license when applying for a 100% tax write-off. Similarly, ensure you calculate your actual expenses and mileage properly.
- Unvalidated claims can result in audits: The IRS doesn’t take too kindly to fraud and invalidated claims for a tax deduction.
- Penalties and fines for misleading finances: Only claim a tax write-off wherever you are allowed to – or else be prepared for a hefty fine.
How can auto loan refinancing help you get tax benefits?
One of the biggest issues with being stuck in a bad car loan is that you will keep having cash flow issues. Even if you are using the car solely for business purposes, you will still have to pay high interest charges on the loan and wait till the end of the financial year to get a refund. This effectively locks up money that could be spent elsewhere.
While auto loan refinancing does not have a direct tax benefit, it can help you reduce the car loan interest you pay every month. This will free up more money which you can use to spend on gas, household expenses, student debt, and more. If you use this money on business-related car costs, you can indirectly benefit by claiming a tax write-off on this amount.
You can also use cash-back auto loan refinancing to borrow an amount equal to the car’s resale value. You can get a portion of the loan in cash, which you can put into your business or use for immediate needs.
Frequently Asked Questions (FAQ)
What kind of interest is tax-deductible?
The Internal Revenue Service (IRS) has listed five types of interest that are deductible on an income tax return.
- Farm business interest
- Non-farm business interest
- Student loan interest
- Investment interest
- Qualified mortgage interest
Can I claim a car loan on my tax return?
- Yes, you can claim a tax deduction if you are using the vehicle for business purposes.
- If you are a freelancer, gig worker, or independent contractor, you can only write off a partial amount. This will only cover the business-related expenses of the car.
- However, if you bought a car for personal reasons like commuting, you cannot claim any tax deductions.
How much of your car payment can you write off?
You can only write off a portion of your car expenses, equal to the business use of the car. If your car use is 70% business and 30% personal, you can only deduct 60% of your auto loan interest. If you bought the car for 100% business use only, you can deduct 100% of the interest.
Can auto loan interest be deducted if it isn’t a business expense?
You can get a tax deduction for the interest on student loans, investments, and qualified mortgages.
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