Are Small Business Loans Tax Deductible? | Tax Deduction 101

We’ve got good news for business owners wondering “are small business loans tax deductible?” If you borrowed money this year, part of those small business loan payments is indeed deductible under   if the interest you pay is a debt being repaid to the lender, the lender is a bank or financial institution and not friends or family, and you’re legally liable for the debt.

The Basics

To make this simple, imagine you have a small business loan for $100,000 and a monthly payment of $8,000.

Let’s say you pay $3,000 towards the loan principal and $5,000 in interest during the first month. For this first example, we’ll assume it is also the last month in the tax year. Your tax deduction on the interest rate, or what you can expense for your business, will be $5,000 for the year.

So, what happens next year? For this simplified example, let’s stick with a flat payment of $5,000 in interest each month for the year, or $60,000 total. We’ll also say the principal payments are a flat $3,000, or $36,000. Your tax deduction in this example would be $60,000 because that is what your expenses on the loan are.

Now that you know how to calculate what part of a business loan is likely tax deductible, let’s apply this to how loans actually work in the real world.

Calculating the actual numbers for the tax deductible expense is easy. Your interest and principal payments are based on the amount owed. If you owed $97,000 after the first payment at an interest rate of 5%, your total interest payment or potential tax deduction would be $4,850 for the month and the additional $150 would go towards the principal. At the end of the year, you add up how much interest you paid, and this is what you can write off if all of the borrowed money was used for business purposes.

In the example above, the total interest paid and what you can deduct is $14,542.50.

It’s pretty easy to see what you’ll be able to write off with this simple math. But this only applies when the loan is used exclusively for business expenses.

If you use any of the borrowed money for personal expenses, this could negate your ability to write off the interest on your taxes. This is why it is important to keep detailed financial records, as well as a paper trail on how the borrowed funds were used. And before you try to deduct any expenses, talk to a licensed CPA as they will be able to assess your specific situation.

So, what about if you’re refinancing the loan?

Unfortunately no, you cannot write off the difference or the interest paid in a refinance situation, but the interest on the new business loan will be tax deductible if it continues to meet the requirements above. And these same rules apply to multiple small business loan types including SBA 7a, short-term loans (if paid off in the year), and lines of credit.

Figuring out how much of your small business loan is tax deductible is easy. As long as you meet the three requirements of the IRS and only use the borrowed funds for business expenses, then you can simply add up the interest paid.

But before doing anything tax related, make sure you talk to your licensed CPA, as each state has their own tax rules and the IRS may have new policies that can benefit your business situation.

The Fine Print

In addition, your loan payments are tax deductible only if you meet the following requirements. You must:

• Be legally responsible for the debt and have a signed contract.
• Intend to pay the money back.
• Have a true debtor-creditor relationship with the lender. If you borrow from a friend or family member, make sure to use a signed promissory note listing the interest rate and follow a clear repayment schedule. Otherwise, the IRS may deny your deduction.
• Spend the loan proceeds on something for your business. If you just keep the money in the bank, you cannot take the tax deduction.

The Exceptions

Answering the question “Are business loans tax deductible?” is complicated because there are loan arrangements where the interest cannot be deducted from your business taxes. You need to be aware of these exceptions before entering into any loan agreement:

• Refinanced Loans – If you take out a second loan from the same lender and use those funds to pay the interest on the first loan, the interest is no longer deductible. However, you can still deduct the interest you pay on the second loan.
• Commercial Real Estate – If you use financing to purchase commercial real estate, the loan origination fees and basis points cannot be deducted as business expenses. Instead, you’re required to include these in the overall cost of the property. Over time, you can deduct them as part of asset depreciation.
• Capitalized Interest – If you rely on loans to finance the construction of a long-term asset, most likely a building, the capitalized interest must be added to the cost of the property rather than deducted from your tax bill.
• Standby Fees – If your lender charges you a fee to keep the funds on standby, the IRS does not recognize this fee as a form of interest payment, meaning it can’t be deducted.

The Examples

Are business loan payments tax deductible for all types of loans? The good news is yes, basically any kind of business loan that involves interest allows for some kind of deduction. To help you get the most tax assistance possible, consider how these deductions apply to common loan examples:

• Term Loans – Loans with a long repayment period are typically structured so you pay more interest upfront, meaning your deduction will be larger at first but get smaller over time. The advantage is that you receive a yearly deduction for as long as you’re paying interest.
• Credit Lines – When a lender makes a line of credit available to you on-demand, you only pay interest (and receive a deduction) on the funds you draw out in any given year. Depending on your business needs and tax burden, having an accessible funding source could work to your strategic advantage.
• Short-Term Loans – If you are required to pay back a loan within a year, as is common of many small business loans, you can deduct the entire interest amount from your taxes. Much like a line of credit, savvy business owners can use this large tax deduction to bolster their bottom line.
• Personal Loans – As long as personal loans are properly reported (as outlined above) the interest us fully deductible. If they are split between business and personal use, the deduction must be split accordingly.
• Expansion Loans – Loans are often used to buy another business. If you intend to run the business, the loan interest is deductible. If you don’t intend to run it, your involvement is considered an “investment” and the interest may not be tax deductible. In this instance, it’s best to ask a tax professional.

Are small business loans tax deductible? In most cases, yes. By taking advantage of this tax deduction, your loan payments will be a little more affordable and your next tax return a little less, well, taxing. To maximize your tax deductions, read our blog about small business tax deductions.