The Internal Revenue Service is pretty clear that deducting personal loans is not allowed on a tax return. In fact, you can't deduct any loan you receive, because a loan is not an expense. The fees and interest charged on a loan, however, may be deductible under certain circumstances. To write off the costs of an auto loan, the auto will need to be used for business reasons, though you might be able to write off interest expenses by financing the auto purchase with a home equity loan.
Rules and Exceptions
The tax law does not allow you to deduct interest on a personal loan of any kind, whether it's for a car, boat or plane; the loan interest and any fees you pay are nondeductible. However, the situation changes if you use a vehicle for business or to generate income. The IRS encourages the earning of income, which in turn generates tax payments. Therefore, any cost you incur to make money is usually deductible.
Loans and Expenses
If you use the car solely for your business, you can deduct the loan interest in full. You must file Schedule C to report the interest as part of your actual car and truck expenses on Line 9. If you don't use the vehicle solely for business, you have to allocate the expense to the portion of the mileage actually used for business. For example, if you only use the car half the time for business, you can only claim half of the interest actually paid as an expense on Schedule C.
Proving It to the IRS
The costs of a personal auto loan, if the vehicle is used for business, are just as deductible as the costs of a dealer loan or a bank loan. But you should document the interest you paid with a written agreement that spells out the rate of interest and the number of installment payments. Statements from the lender showing balances and payments, as well as canceled checks and receipts, will help. Simply taking a bundle of cash from a relative and making payments from time to time won't cut it if the IRS audits you, which is likely to happen if you're claiming excessive expenses for your business.
Doing it the Home-Equity Way
If you don't use the car for business, you can borrow the money to buy the car in a tax-deductible way by using a home equity line of credit. You have to own a home and have enough equity to qualify for a second mortgage to take this route. The equity in your property is collateral for the loan, and the loan interest is deductible on Schedule A as an individual deduction, as long as you itemize.
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