Is Interest on Car Loans Deductible?

Deducting interest you pay on a car loan can help reduce your tax liability, but you must qualify to claim the deduction. If you deduct the interest on a car loan when you file your federal income tax return, be prepared to prove that you are eligible to take the deduction in case the IRS selects you for an audit. Generally, the interest you pay on a car loan is not tax deductible, although there are a few exceptions.

Personal Interest

You cannot deduct interest on your federal income tax return for a loan you take to buy a car for personal use, according to IRS guidelines. This type of interest falls under the category of personal interest, which you cannot claim as an itemized deduction on Schedule A. Types of interest you can deduct on Schedule A Form 1040 include home mortgage interest and investment interest.

Business Expense

If you intend to use your vehicle for business purposes, you may be able to deduct some of the interest you pay on the auto loan. Use of the vehicle must qualify as a business expense. Business owners who regularly use a vehicle in the operation of their business can deduct expenses related to driving and maintaining a vehicle. In this case, the interest you pay on the car loan is considered an allowable business expense on Schedule C Form 1040. Complete Part IV of the form if you claim a deduction for car or truck expenses in Part II.

Home Equity Loan

If you use the money you borrow with a home equity loan to purchase a vehicle, the interest you pay on the loan is tax deductible. Like mortgage interest, you can deduct the interest you pay on a home equity loan by itemizing deductions on your federal income tax return. Because you use your home to secure a home equity loan, if you fail to make the loan payments, you could lose it. Taxpayers who qualify to deduct the interest usually pay a lower interest rate on a home equity loan compared to an auto loan. Check first with your tax consultant, because high-income taxpayers cannot deduct home equity loan interest if they use the money for purposes other than improving their principal residence or a second home. This is the case when the Alternative Minimum Tax applies in addition to the regular federal income tax after credits are deducted.

Home Equity Line of Credit

You could also use a home equity line of credit to buy a car. Like a home equity loan, you secure a home equity line of credit with your home. It doesn't matter for what purpose you use the money, and most times you can deduct the interest you pay on home equity debt. Restrictions apply if you borrow more money than your property is worth, in which case you can only deduct part of the interest you pay on the loan. Unlike a home equity loan that allows you to borrow a lump sum at a fixed rate of interest, a home equity line of credit has a revolving balance. The interest rate is variable, which means that your monthly payments can vary.