Is Car Loan Interest Tax Deductible?

Your car payment is one of your most significant monthly expenses, so you may want to find ways to keep it as low as possible. In addition, since you’re paying interest on your auto loan, you’ll likely wonder if you can write off the interest on your tax return. Check out this helpful guide to learn more about tax deductions for car loan interest. 

Is Car Loan Interest Tax-Deductible?

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Unfortunately, most people can’t claim a tax deduction for the interest they pay on their auto loans. This type of deduction is usually available only to business owners, freelancers, and independent contractors. If you’re eligible, you have to claim the deduction as a business expense. In addition, you won’t be able to deduct your car loan interest if you’re working under an employer or receiving some form of financial assistance from the government.

How to Claim a Car Loan Interest Deduction if You Financed a Personal Vehicle

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If you’re a freelancer or small business owner who uses your personal vehicle partly for business purposes, you may qualify for the auto loan interest deduction. In this case, interest on your car loan is regarded as a car-related business expense, similar to gas and repairs. You have to claim all of your vehicle deductions on your Schedule C tax form. As with other car-related expenses, you can write off your car loan interest using one of the two following methods:

Actual Expense Method

The actual expense method enables you to deduct all of your vehicle expenses directly related to your work, including the interest portion of your car payments. Many self-employed people use the exact vehicle for both personal and business needs. For tax purposes, you can deduct the part of your car-related expenses that corresponds to the business use of your car. For instance, if you use your vehicle 60% for business and 40% for personal purposes, you can only write off 60% of your car loan interest. 

In addition to the interest on your auto loan, you can deduct many other vehicles operating costs with the actual expense method, including gas, maintenance, repairs, car insurance premium, registration fees, and license fees. You’re also allowed to claim a depreciation deduction for your car. 

Using the actual expense method for most freelance workers and independent contractors usually results in a higher deduction. However, you have to make sure you stay on top of your recordkeeping if you decide to deduct actual vehicle expenses. Then again, this method can be easy if you have the right organizational tools. 

Standard Mileage Method

In contrast, if you choose the standard mileage method, you won’t claim your vehicle expenses as separate deductions. Instead, all of the write-offs are calculated based on the IRS’ standard mileage rate, which stands at $0.56 in 2021. You can deduct this amount for every mile you drive on a business-related trip. 

To use the standard mileage method, you need to maintain a log to keep accurate business mileage records. Bear in mind that commuting miles aren’t deductible. These are the miles you drive to and from your place of business, such as your office or co-working space. Other vehicle-related costs that you shouldn’t include in your standard mileage deduction are parking fees, toll charges, registration fees, and car washes. Although it’s simpler than the actual expenses method, this method still requires you to do some expense tracking. 

Let’s look at an example of how the standard mileage deduction works. Suppose you’re a self-employed personal shopper who frequently needs to meet your customers for styling appointments. These client visits add 5,000 miles to your vehicle’s odometer each year. To calculate the total deductible amount, multiply 5,000 by the standard mileage rate of $0.56. This yields a write-off of $2,800. 

Generally, the standard mileage method is a better way to deduct your vehicle expenses if you do a lot of business-related driving. It’s the preferred method for rideshare drivers and freelance truckers. If you’re a freelancer who works out of your home office, you’ll probably save more on your tax bill if you opt for the actual expense method. 

How to Deduct Your Car Loan Interest if You Financed a Vehicle Through Your Business

If you obtained auto financing under your business’ name, you’d likely make your monthly payments directly from your company’s bank account. If this is true, it’s probably safe to assume that you’re using your business-owned vehicle exclusively for work. In this case, you’re allowed to write off 100% of the interest you’re paying on your car loan. However, it’s recommended that you use the actual expense method as it can help you claim a larger deduction. 

What Are the Benefits and Risks of Taking a Car Loan Interest Deduction?

While it can be tempting to write off the interest on your auto loan, you should carefully consider the risks involved. The apparent benefit of deducting your car loan interest is that it makes your loan more affordable. If you’re paying a high-interest rate, such a deduction can help you save hundreds or thousands of dollars. 

If you’re planning to claim a car loan interest deduction on your tax return, you have to make sure you’re eligible to do so. If the IRS decides that you don’t qualify for the write-off, you may face a hefty penalty that significantly increases your tax bill. 

Another drawback to writing off your car loan interest is that you may be targeted as a candidate for a tax audit. If you’re audited, you’re required to provide proof of the validity of the deductions you made and your eligibility to claim them, which can cause undue hassle and stress. 

The best way to save on auto financing is to get a good car loan deal in the first place. If you’re thinking of buying a used car in Cleveland, Ohio, you can find your ideal ride and auto loan at the North Coast Auto Mall of Cleveland. Contact us today to find out about our flexible and cost-effective financing solutions.