Learn which type of loan interest payments are--and are not--deductible.
Interest you pay on business loans is usually a currently deductible business expense. It makes no difference whether you pay the interest on a bank loan, personal loan, credit card, line of credit, car loan, or real estate mortgage for business real property. Nor does it matter whether the collateral you used to get the loan was business or personal property. If you use the money for business, the interest you pay to get that money is a deductible business expense. It's how you use the money that counts, not how you get it. Borrowed money is used for business when you buy something with the money that's deductible as a business expense.
For example, Max, the sole proprietor owner of a small construction company, borrows $50,000 from the bank to buy new construction equipment. He pays 6% interest on the loan. His annual interest is deductible on his Schedule C, Form 1040 because it is for a business loan.
When Does the Deduction Kick In?
Your deduction begins only when you spend the borrowed funds for business purposes. You get no business deduction for interest you pay on money you keep in the bank. Money in the bank is considered an investment.
Because interest on money you borrow for personal purposes—like buying clothes or taking vacations—isn't deductible, you should avoid paying this type of interest whenever possible. If you own a business, you can do this by borrowing money to pay your business expenses and then using the money your business earns to pay off your personal debt. By doing this, you "replace" your nondeductible personal interest expense with deductible business expenses.
Car Loans
If you use your car for business, you can deduct the interest you pay on your car loan as an interest expense. You can take this deduction whether you deduct your car expenses using the actual expense method or the standard mileage rate because the standard mileage rate was not intended to encompass interest on a car loan.
If you use your car only for business, you can deduct all the interest you pay. If you use it for both business and personal reasons, you can deduct the business percentage of the interest. For example, if you use your car 60% of the time for business, you can deduct 60% of the interest you pay on your car loan.
Loans to Buy a Business
If you borrow money to buy an interest in an S corporation, partnership, or LLC, it's wise to seek an accountant's help to figure out how to deduct the interest on your loan. It must be allocated among the company's assets and, depending on what assets the business owns, the interest might be deductible either as a business expense or as an investment expense, which is more limited. Interest on money you borrow to buy stock in a C corporation is always treated as investment interest. This is true even if the corporation is small (also called "closely held") and its stock is not publicly traded.
Loans From Relatives and Friends
If you borrow money from a relative or friend and use it for business purposes, you may deduct the interest you pay on the loan as a business expense. However, the IRS is very suspicious of loans between family members and friends. You need to carefully document these transactions. Treat the loan like any other business loan: Sign a promissory note, pay a reasonable rate of interest, and follow a repayment schedule. Keep your canceled loan payment checks to prove you really paid the interest.
Businesses That Earn Over $25 Million
Starting 2018, all businesses with average gross receipts of $25 million or more during the prior three years are allowed to deduct interest payments only up to 30% of their adjusted taxable income (income without including depreciation, interest expenses, NOLs). Any undeductible interest may be carried forward to be deducted in future years. However, real property and farming businesses may elect out of this prohibition and thereby deduct 100% of their interest expenses each year. To do so, they must depreciate their real property under longer periods—30 years (instead of 27.5) for residential property and 40 years (instead of 39) for nonresidential property.
Interest You Can't Deduct
You can't deduct interest:
- on loans used for personal purposes
- on debts your business doesn't owe
- on overdue taxes (only C corporations can deduct this interest)
- that you pay with funds borrowed from the original lender through a second loan (but you can deduct the interest once you start making payments on the new loan)
- that you prepay if you're a cash basis taxpayer (but you may deduct it the next year)
- on money borrowed to pay taxes or fund retirement plans, or
- on loans of more than $50,000 that are borrowed on a life insurance policy on yourself or another owner or employee of your business.
Points and other loan origination fees that you pay to get a mortgage on business property aren't deductible business expenses. You must add these costs to the cost of the building and deduct them over time using depreciation. The same is true for interest on construction loans if you are in the business of building houses or other real property. Manufacturers of substantial amounts of goods—defined as goods worth $1 million or more and with an estimated production period of more than one year—must also depreciate the interest on money borrowed to produce their goods.
To learn more about what you can deduct, see Nolo's Business Deductions area.
FAQs
Interest you pay on business loans is usually a currently deductible business expense. It makes no difference whether you pay the interest on a bank loan, personal loan, credit card, line of credit, car loan, or real estate mortgage for business real property.
Are business loan interest payments tax-deductible? ›
The IRS business loan interest deduction lets you write off the annual interest you paid on a business loan. With the business loan interest tax deduction, you can deduct the amount you paid in business loan interest from your tax liability. This deduction reduces the amount you owe in taxes.
Can you deduct loan interest payments? ›
Though personal loans are not tax-deductible, other types of loans are. Interest paid on mortgages, student loans, and business loans often can be deducted on your annual taxes, effectively reducing your taxable income for the year.
Are corporations allowed to deduct interest payments as an expense? ›
Answer and Explanation: Corporations are allowed to deduct interest payments as an expense. Corporations are not allowed to deduct dividend payments to stockholders as an expense. The differential tax treatments of interest payments and dividend payments encourages firms to use debt in their capital structure.
Can I write off interest from SBA loan? ›
Fortunately for you, SBA 7(a) loans are term loans (the only difference is they're guaranteed by the SBA). This means you can deduct your interest payments. Most term loans are structured so that you pay higher interest at the beginning of the repayment schedule and lower towards the end.
What is the IRS form for business loan interest? ›
Use Form 8990 to calculate the amount of business interest expense you can deduct and the amount to carry forward to the next year.
Why is interest considered a business expense and a principal payment for a loan is not? ›
Even if you're paying off the principal and interest of your loan. You have to actually use the cash you've been issued in order to be eligible for the deduction. Money that is left in the bank and goes unspent is considered an investment and not an expense, which is why that interest isn't tax-deductible.
Can you deduct car loan payments for business? ›
Yes, you can write off the interest on a car loan if it's used for business purposes. You'll need to use the actual expense method to deduct this expense and you can only write off the business use portion of the interest. Also, keep in mind that your principal payments aren't deductible.
Which of the following types of interest expenses is not deductible? ›
Not all types of interest are deductible. Specifically, the IRS does not allow you to deduct personal interest such as: The interest you pay on a loan to buy a car for personal use. Credit card and installment loan interest on personal expenses.
Is repayment of a loan considered income? ›
The personal loan payments you make are not tax deductible. The money you receive isn't income, and repaying the principal balance won't affect your taxes one way or the other. You won't even need to include the loan or file any extra forms with your tax return.
Interest you pay on business loans is usually a currently deductible business expense. It makes no difference whether you pay the interest on a bank loan, personal loan, credit card, line of credit, car loan, or real estate mortgage for business real property.
Is interest paid to the IRS tax-deductible for corporations? ›
Business owners must be aware that, generally, interest and/or penalties paid to the IRS are not deductible on tax returns. This includes fines and penalties paid to a government or specified nongovernmental entity for the violation of any law. However, there are exceptions to this rule.
What is the limit on interest deduction? ›
Before the TCJA, the mortgage interest deduction limit was on loans up to $1 million. Now, the loan limit is $750,000. For the 2024 tax year, married couples filing jointly, single filers and heads of households can deduct up to $750,000. Married taxpayers filing separately can deduct up to $375,000 each.
How do I report SBA loan payments on my taxes? ›
How do I report an SBA loan on my taxes? You don't need to report an SBA loan as income on your tax return. However, you can deduct any interest you pay on the loan amount from your taxes.
Why is loan repayment not an expense? ›
Your debt repayment is not an expense, it's an internal transfer. The only part that's an expense is the interest. The rest of the money was spent some time in the past, when you incurred the debt. The same principle applies when you put money into your savings account.
How does business loan repayment work? ›
You receive the funds in a lump sum or as a line of credit. You pay back what you borrow on a prearranged payment schedule. If you don't repay the loan on time, a lender may consider your loan to be in default and can seize your collateral or other assets.
Is business loan interest 100 tax deductible? ›
Interest you pay on business loans is usually a currently deductible business expense. It makes no difference whether you pay the interest on a bank loan, personal loan, credit card, line of credit, car loan, or real estate mortgage for business real property.
What type of loan interest is tax deductible? ›
You can deduct several types of interest, including mortgage interest, student loan interest, investment interest, and business loan interest.
Does repayment of a loan count as income? ›
The personal loan payments you make are not tax deductible. The money you receive isn't income, and repaying the principal balance won't affect your taxes one way or the other. You won't even need to include the loan or file any extra forms with your tax return.
Are business loan prepayment penalties tax deductible? ›
Prepayment penalties are tax deductible in the State of California and at the federal level, meaning that the penalty could be reduced by half for borrowers in the top tax brackets.
