Is Auto Loan Interest Deductible?
Generally, an individual investor cannot deduct interest paid on loans, other than on a home mortgage. The interest on car loans and leases, therefore, is typically not deductible for the individual taxpayer. However, if you own a business, or if you use a car 100 percent for business in the service of your employer and your employer does not reimburse you for the cost of the vehicle, you may be able to claim the vehicle as a business expense or a miscellaneous itemized deduction.
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Deductibility of Consumer Loans
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In the past, the interest on consumer loans, including credit card interest and car loans, was tax deductible. However, when Congress simplified the tax code in 1986, they eliminated the deductibility of consumer loan interest. They did, however, keep the deduction for home mortgages, currently limited to the interest on a home loan of up to $1 million dollars.
Tax Deductibility of Business Interest
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If you own a business, and you purchase the vehicle for use in your business, or if your business owns the vehicle, you may be able to deduct the entire cost of the vehicle, plus the interest on the loan. The interest on loans for business purposes is generally tax deductible as an ordinary business expense. To claim the deduction, list the interest expense - along with the cost of the vehicle - on Schedule C, Income or Loss from Business, and file it along with a 1040, Individual Income Tax Return, if the business is a pass-through entity, such as an S-Corporation, LLC, partnership or sole proprietorship. If the business is a C corporation, you will simply list the expense on your Form 1120, Corporate Income Tax Return.
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Unreimbursed Employee Expense
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If your employer requires you to purchase a vehicle as part of your employment, and you use the vehicle for business purposes, you may be able to deduct the acquisition costs of the vehicle, including loan interest, as an unreimbursed employee expense. To claim this deduction, file a Schedule A, Miscellaneous Itemized Deductions, and an IRS Form 2106 or Form 2106EZ, Unreimbursed Employee Expense with your individual income tax return. You can only take a miscellaneous itemized deduction to the extent it exceeds 2 percent of your modified adjusted gross income.
Alternatives
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You may be able to take out a home equity loan to pay off your car loan. The reason you may consider this is because home equity loan interest on a loan of up to $100,000 is tax deductible, while the interest on a consumer car loan is not. Use caution, however: If you lose your job or become disabled and cannot work, you have essentially pledged your home as collateral to get a lower interest rate on a car loan. Also, you may not be able to deduct your home equity loan interest if you are subject to the alternative minimum tax.
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