IRS Form 8890 for Deducting Retirement Loan Interest

While most interest on loans from retirement accounts is non-deductible personal interest, a specific exception exists. Individuals can claim a deduction if the loan is secured by their primary residence and they meet all eligibility criteria. Qualified taxpayers report this interest as a home mortgage interest deduction on their tax return.

Determining Eligibility to Deduct Interest

Interest paid on a loan from a retirement plan is normally treated as non-deductible consumer interest. This rule applies to most loans from 401(k)s and similar plans. However, an exception allows this interest to be treated as deductible home mortgage interest if the loan meets several strict requirements from the Internal Revenue Service.

The first condition is that the loan must be secured by the taxpayer’s main home, which is the primary residence where they ordinarily live. This can be a house, condominium, cooperative, mobile home, or boat. The loan agreement must explicitly state that the loan is secured by this residence for the interest to be deductible.

Another requirement is that the loan must originate from a qualified employer plan, such as a 401(k), 403(b), or defined benefit pension plan. It is important to note that loans from Individual Retirement Arrangements (IRAs) or Roth IRAs are not eligible for this interest deduction.

The taxpayer cannot be a “key employee” of the company sponsoring the plan at the time the loan is made. Key employees are barred from deducting the interest on any loan from that employer’s plan, even if it is secured by their main home.

The key employee determination is based on three tests:

• The 5% owner test, which classifies anyone who owns more than 5% of the business.
• The 1% owner test, which applies to individuals who own more than 1% of the business and have annual compensation of more than $150,000.
• The officer test, which designates certain officers of the company earning more than $230,000 in 2025.

For example, an individual who owns 2% of their employer’s company and earns $170,000 would be a key employee under the 1% owner test and could not deduct the interest.

Documentation and How to Report the Deduction

To claim the deduction, a taxpayer must have the correct documentation and report the amount on the proper tax schedule. While no special IRS form is required, keeping detailed records is necessary to substantiate the deduction in case of an IRS inquiry.

You will need the original loan agreement and a statement from the plan administrator detailing the total interest paid on the loan during the tax year. This document functions similarly to the Form 1098, “Mortgage Interest Statement,” that traditional lenders issue and provides the amount you can deduct.

The deductible interest is not reported directly on Form 1040 but is included on Schedule A (Form 1040), “Itemized Deductions.” The amount should be entered on the line for home mortgage interest not reported on a Form 1098. You do not need to attach these documents to your return but must keep them with your tax records.