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Of all the usual subjects taught in school, the tax implications of financing a car is decidedly not among them.
But this knowledge is important to anyone who has or is considering a vehicle loan. What’s more, if you are in the market to replace an auto loan with a more affordable one, understanding how the refinancing process affects your taxes is especially key.
A tax professional, such as an accountant or attorney, can provide you with formal advice when it comes to how to follow applicable laws. Here are some general pointers and answers to common questions to help kickstart your knowledge about the intersection between taxes and auto loans.
Refinancing a car does not typically lead to a sales tax charge. Refinancing basically means that you are taking out a new loan against the vehicle and using the funds accessed through the new loan to pay off your existing loan.
In most cases, the borrower is switching lenders when they refinance an auto loan. There are other actions you can take as part of refinancing, like adding or removing a co-borrower. Sales tax is levied on transactions where goods are “consumed.”
So, because the car is not being sold as part of a refinance—you remain the owner even if the lien holder is changing—the process should not trigger a tax payment. The initial purchase transaction would have been the occasion where sales tax was due and collected.
It’s wise to consult your state motor vehicle bureau about any potential sales tax due when adding or removing a co-borrower from an auto loan, as this particular action could be considered a transaction subject to sales tax, in that there is a transfer of ownership of the vehicle taking place. The co-borrower rolling off the title is effectively releasing a stake in the car.
Laws on vehicle title changes and tax may differ depending on where you reside. There also could be exemptions to a requirement to pay sales tax in this situation if, for instance, the co-borrower is a family member.
You may also wonder if the funds you get from a lender as part of an auto loan refi are viewed as taxable income by the state you live in or by the IRS. In the eyes of the government, money you get as a loan is not considered income and therefore aren’t taxed like the salary you earn from your job, for example. The reasoning here is that taking on debt is not the same as earnings, since the money must be paid back.
Many people are aware of the tax incentives available that help offset the costs of a home loan, with the mortgage interest deduction probably being the most familiar. But what about auto loans in general, and refinance costs specifically?
Unfortunately, there is not a comparable set of tax incentives that apply to car loans. Moreover, when you refinance an auto loan, there aren’t any explicit tax benefits to take advantage of. The story does not end there, though.
The mortgage interest deduction allows you to lower your taxable income based on the interest you pay on a home loan. Again, for the most part, drivers are not able to take a similar deduction related to the expense of auto loan interest.
But there is a major exception: if you are a business owner or self-employed and use your car for work, you may be able to write off interest paid on that car’s loan, among other expenses related to operating the vehicle, such as fuel and tolls. Gig economy jobs like driving for a car-share company generally qualify for this tax incentive.
Talk to your tax professional about how to take advantage of this type of deduction, as it requires detailed record-keeping of how the car is used in the course of your work and/or toward your business. By lowering how much of your income is subject to tax, you’ll be able to keep more money in your own pocket, and invest more back into your business.
One of the major reasons car owners refinance their auto loans is to lock in a more affordable monthly payment, which can often be achieved when the refi process lowers the interest rate drivers are paying.
Let’s consider an example. Imagine you are one year (12 months) into a 60-month, 10% APR auto loan on a vehicle that costs $20,000. Refinancing into a new auto loan with a new 60-month term drops your interest rate from 10% down to 5% APR. Your payment savings will be about $109 per month. But you are also going to spend less on interest charges over the course of the loan. If you had stuck with the original loan, the overall amount you’d spend on interest is about $5,500. By refinancing, you will avoid roughly $3,280 in interest costs.
Onto the question of taxes. Will making a change to your auto loan interest rate by refinancing have an impact on your taxes? For drivers who are eligible to take an interest deduction (recall that we covered this topic above), then there is a sort of indirect impact.
Consider the example we shared earlier, where you lowered your auto loan interest rate from 10% to 5% by refinancing. Let’s assume you are a ride-share driver who can write off some portion of the interest you pay on your auto loan; in that case, the deductions you can make to your taxable income will go down accordingly.
In the example, you cut your total borrowing costs by more than $3,000, which in this hypothetical would mean the size of your tax write-offs would also go down (all else being equal), potentially leaving you subject to higher tax bills than otherwise.
Consider running the numbers with your tax professional on the trade-off between interest-charge savings and the elevated tax burden if this scenario applies to you.
It’s only in a select few circumstances that your taxes are affected by opening or refinancing an auto loan.
For those who have a car mainly for personal use, there’s not much to fret over when it comes to taxes. If you drive your car for work, there are incentives you may be eligible for that reduce your income tax liability if you take out a loan on your vehicle. For that reason, most drivers won’t need to seek out a tax professional to help them navigate the car loan refinancing process.
When you’re planning to write off interest and other expenses of vehicle use, it’s a good idea to do that with the guidance of your accountant to ensure you’re doing so in accordance with applicable regulations.
Is easier than over to swap out an auto loan that isn’t offering you the best deal.
Refinancing can lower your monthly loan payments and enable you to access a more affordable interest rate. There are very few tax-related concerns to navigate, and of those, most drivers aren’t affected.
You can and should consult a tax pro if you have specific questions, as it’s better to be proactive and gather the right information from trusted experts before you make any big financial decisions.
To start your auto refinance journey, check out RateGenius’s Auto Refinance Calculator, which can give you an idea of just how much you can save by replacing a costly auto loan.
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