When Is Car Loan Interest Tax Deductible?

While interest on a personal car loan is generally not tax-deductible, specific situations allow for this deduction. Understanding these circumstances is important for taxpayers.

Eligibility for Deducting Car Loan Interest

Interest paid on loans for vehicles used strictly for personal purposes, such as commuting or family errands, is not deductible. The IRS considers this personal interest, which is not permitted as a tax deduction.

An exception applies to individuals who use their vehicle for business. Self-employed individuals, independent contractors, and small business owners may deduct the business-use portion of their car loan interest if the vehicle generates income for a trade or business. Employees cannot deduct car loan interest, even if they use their personal vehicle for work-related activities not reimbursed by their employer.

Heavy sport utility vehicles (SUVs), trucks, or vans with a Gross Vehicle Weight Rating (GVWR) exceeding 6,000 pounds may qualify for accelerated depreciation deductions. However, the deductibility of their loan interest still depends on their business use. The interest portion of the loan for these vehicles, if used for business, is deductible in proportion to their business use.

Car loan interest might also be deductible if financed with a home equity loan or line of credit (HELOC). Interest on a home equity loan or HELOC is only deductible if the funds are used to buy, build, or substantially improve the taxpayer’s home that secures the loan. Using a home equity loan to purchase a car does not automatically make the interest deductible; it must meet the criteria for “qualified residence interest.”

Qualified residence interest is limited to interest on up to $750,000 of combined mortgage debt for loans incurred after December 15, 2017. For loans taken out on or before this date, a higher limit of $1 million applies. This combined limit includes primary mortgages and any home equity loans or HELOCs. The loan must also be secured by the taxpayer’s main home or a second home.

Calculating the Deductible Interest Amount

Determining the deductible amount involves calculating the vehicle’s business-use percentage. This percentage is derived from business mileage compared to total mileage during the tax year. For example, if a vehicle is driven 10,000 miles in a year, and 6,000 of those miles are for business, the business-use percentage is 60%.

To calculate the deductible interest, this business-use percentage is applied to the total interest paid on the car loan during the year. If the total interest paid was $1,000 and the business-use percentage is 60%, then $600 would be the deductible portion. This method is part of claiming “actual expenses” for vehicle use, which includes other costs like fuel, repairs, and insurance, all prorated by the business-use percentage.

Taxpayers can obtain the total interest paid on their car loan from annual loan statements. For home equity loans, the lender issues Form 1098, “Mortgage Interest Statement,” which reports the interest paid. This form substantiates the interest amount.

Maintaining detailed records is important for supporting the calculated deductible amount. The IRS requires a contemporaneous mileage log for each business trip. This log should include:
Date of the trip
Starting location
Destination
Business purpose
Miles driven for each specific trip

Annual odometer readings at the beginning and end of the year are also important for verifying total mileage. Without detailed records, the deduction may be disallowed during an audit.

Taxpayers choose between deducting actual expenses (which includes prorated interest) or using the standard mileage rate. If the standard mileage rate is chosen, car loan interest cannot be deducted separately, as the standard rate accounts for most vehicle operating costs, including depreciation and interest. Therefore, the actual expense method must be elected to deduct car loan interest.

Reporting Car Interest Deductions

Reporting deductible car loan interest depends on its deductibility. For self-employed individuals and small business owners, the deductible portion of car loan interest is reported on Schedule C (Form 1040), “Profit or Loss From Business.” The interest expense is entered on the “Other Interest” line within the expenses section of Schedule C.

When interest is from a home equity loan or HELOC that meets qualified residence interest rules, it is reported on Schedule A (Form 1040), “Itemized Deductions.” This interest falls under the home mortgage interest section of Schedule A. Taxpayers must choose to itemize their deductions rather than taking the standard deduction to claim this interest.

To support these deductions, taxpayers must retain specific documentation. For home equity loan interest, Form 1098, provided by the lender, is the primary document detailing the amount of interest paid. For business-use vehicle interest, detailed mileage logs are essential, as they substantiate the business-use percentage applied to the interest and other vehicle expenses. Loan statements showing all interest payments made throughout the year are also necessary.

When completing tax forms, taxpayers transfer the calculated deductible interest amount to the appropriate line. On Schedule C, this is the business portion of the interest expense. On Schedule A, the qualified residence interest from the home equity loan is entered as home mortgage interest. Ensure only the eligible, calculated amount is reported and all supporting records are available for an IRS inquiry.