Car Loan Interest Deduction

The car loan interest deduction is the deduction allowed for qualified passenger vehicle loan interest under Internal Revenue Code section 163(h)(4), added by Public Law 119-21 (the One Big Beautiful Bill Act) in July 2025. Interest on a personal car loan is ordinarily nondeductible personal interest; section 163(h)(4)(A) removes qualified passenger vehicle loan interest from that category for taxable years beginning after December 31, 2024 and before January 1, 2029. Qualified interest is interest paid or accrued on debt the taxpayer incurred after December 31, 2024 to buy an applicable passenger vehicle for personal use, secured by a first lien on that vehicle. Up to $10,000 a year counts, reduced at higher incomes. Section 63(b)(7) makes it available to taxpayers who take the standard deduction, and it is claimed on Schedule 1-A (Form 1040), whose Part IV the IRS headed "No Tax on Car Loan Interest." That heading describes the goal rather than the effect: the interest reduces taxable income, and nothing about the loan becomes tax-free.

Where it sits on the return. A deduction reduces the income that tax is figured on, so $3,000 of deductible interest saves $660 at a 22 percent marginal rate, while a $3,000 tax credit would cut the tax bill by the full $3,000. This one is neither an itemized deduction nor an adjustment to income. Section 63(d)(2) excludes anything listed in section 63(b) from itemized deductions, and section 63(b)(7) lists it as a deduction subtracted from adjusted gross income. So it is taken in addition to the standard deduction, and it leaves adjusted gross income where it was. It travels on Schedule 1-A with the qualified tips deduction, the qualified overtime compensation deduction and the enhanced deduction for seniors, and Schedule 1-A's total reaches Form 1040 as a single line after adjusted gross income.

The vehicle. Section 163(h)(4)(D) defines an applicable passenger vehicle as a car, minivan, van, sport utility vehicle, pickup truck or motorcycle with a gross vehicle weight rating under 14,000 pounds, made mainly for public roads, with at least two wheels, treated as a motor vehicle under title II of the Clean Air Act, whose original use begins with the taxpayer and whose final assembly occurred in the United States. Original use is what rules out used vehicles. The final regulation, Treasury Regulation section 1.163-16(e)(2), says original use begins with the first person to take delivery after the vehicle is sold, registered or titled, and a borrower qualifies only if the loan documents treat the vehicle as new. A dealer's demonstrator can still qualify, because a dealer holding a car for sale is not treated as its first user. Buying the car at the end of a lease does not, because the leasing company was the first user. The assembly test turns on where the vehicle was assembled, not on the brand or on where its parts were made. A buyer may rely on the plant of manufacture encoded in the vehicle identification number, which the National Highway Traffic Safety Administration's VIN decoder reads, or on the final assembly point printed on the vehicle's window label.

The loan. The debt must be incurred by the taxpayer after December 31, 2024, so a loan signed in early 2025, before the law was enacted on July 4, 2025, counts. It must be used to buy the vehicle and be secured by a first lien on it, which is why a purchase put on a credit card generally does not qualify. The statute excludes lease financing, loans for fleet sales, loans for a commercial vehicle not used for personal purposes, loans on a salvage-title vehicle, loans for a vehicle meant for scrap or parts, and debt owed to a related person within the meaning of section 267(b) or 707(b)(1), which reaches a loan from a parent. The regulations settle what else in the amount financed can count: extended warranties, service plans, GAP coverage, credit insurance, sales tax, and title and registration fees are customarily financed and qualify, while negative equity rolled in from a trade-in, collision or liability insurance other than a credit insurance product, a trailer, and cash the lender pays out to the buyer do not. When a loan mixes the two, interest is split pro rata, and a down payment is applied first against the nonqualifying part. In the regulation's own example, a $40,000 loan with $4,000 of nonqualifying items leaves 90 percent of each interest payment eligible.

Personal use, refinancing and death. The vehicle counts as bought for personal use if, when the loan is taken out, the borrower expects it to be used more than 50 percent of the time by the borrower, a spouse, or certain relatives and household members, measured over the period the borrower expects to own it. Use as an employee counts as personal use. A rideshare driver expecting 15 percent business use qualifies; a contractor expecting 60 percent does not. Where some qualifying interest could also be deducted as business interest, the same dollars can be deducted once, in whichever place the taxpayer chooses. A refinance keeps the deduction if the new loan is secured by a first lien on the same vehicle, but only up to the balance refinanced, so the interest on cash taken out does not count. A new borrower taking over the loan loses it, with one exception: an heir or surviving co-owner who takes on the loan by reason of the borrower's death.

The VIN and the lender's statement. Section 163(h)(4)(B)(iii) denies the deduction unless the vehicle identification number is on the return. Section 6050AA requires a lender that receives $600 or more of interest on a qualifying loan in a year, in the course of its business, to report it to the IRS and to send the borrower a statement by January 31 of the following year. The form is Form 1098-VLI, Vehicle Loan Interest Statement, and it shows the interest, the VIN, the origination date, and boxes for whether original use began with the borrower and whether final assembly was in the United States. For 2025, Notice 2025-57 let lenders meet the requirement by making a statement of the year's interest available to the borrower, and the final regulations declined to extend that relief. The $600 test is applied loan by loan, so a loan that paid less than $600 of interest in the year may produce no form at all, and the interest on it can still be deducted.

The steps follow Part IV of Schedule 1-A in order.

1. Confirm each loan qualifies: a new, U.S.-assembled vehicle, a purchase loan taken out after 2024, secured by a first lien, for personal use.
2. Total the qualifying interest paid or accrued during the year, from the lender's statement, less any of it already deducted elsewhere, such as on Schedule C. Enter each vehicle's identification number.
3. Apply the $10,000 cap, which is one cap per return whatever the filing status. A couple filing jointly with two qualifying loans shares it.
4. Compare modified adjusted gross income to the threshold. That is adjusted gross income plus any foreign earned income, or income from Puerto Rico or certain U.S. territories, excluded under sections 911, 931 and 933. The threshold is $100,000, or $200,000 on a joint return.
5. Apply the phase-out. Divide the excess by $1,000, round any fraction up to the next whole number, multiply by $200, and subtract the result from the capped interest. The deduction cannot go below zero.

Take an example. Kenji is single and in 2026 buys a new SUV whose window label lists a U.S. final assembly point, financing it with a loan secured by the vehicle. His lender's statement shows $3,400 of interest paid during the year.

If Kenji's modified adjusted gross income is $96,000, he is under $100,000, no reduction applies, and he deducts all $3,400. At a 22 percent marginal rate that saves him $748 of federal income tax.

If instead his modified adjusted gross income is $112,400, the excess is $12,400. Divided by $1,000 that is 12.4, which rounds up to 13. Thirteen times $200 is a $2,600 reduction, so his deduction is $3,400 minus $2,600, or $800, worth $176 at 22 percent. Had the rule rounded down, as the tips and overtime deductions do, the reduction would have been $2,400 and the deduction $1,000. At any modified adjusted gross income above $116,000 his $3,400 is gone entirely, and even a borrower with the full $10,000 of interest loses all of it once modified adjusted gross income passes $149,000, or $249,000 on a joint return.

Pros

• Available whether or not you itemize, so it reaches borrowers who take the standard deduction.
• Covers the interest on customarily financed extras such as sales tax, fees, extended warranties and GAP coverage, not only the vehicle's price.
• Survives a refinance on the same vehicle, up to the balance refinanced.
• Loans taken out in 2025 before the law passed still qualify.

Cons

• A deduction, not a credit, so $1,000 of interest saves only $1,000 times your marginal rate, and nothing at all if your taxable income is already zero.
• Every condition is fixed at purchase. A used car, a lease, a foreign-assembled vehicle or a loan without a first lien on the car misses it, and nothing done at tax time repairs that.
• The phase-out rounds against the borrower and starts at a lower income than the tips and overtime deductions, at $100,000, or $200,000 on a joint return.
• No inflation adjustment, so the cap and thresholds lose value each year.
• It ends after tax year 2028, while a five- or six-year loan taken out now keeps charging interest into 2029 and beyond.
• Interest on negative equity rolled in from a trade-in, and on cash taken out in a refinance, does not count.