Tracing rules
Interest is deductible based on how the borrowed funds were used, not on the type of loan. A home equity loan whose proceeds were used to buy business equipment produces deductible business interest. A business loan whose proceeds were diverted to personal use produces non-deductible personal interest.
Section 163(j) limitation
Larger businesses face a 30% adjusted-taxable-income limitation on business interest deductions. The limit does not apply to taxpayers with average annual gross receipts under the inflation-adjusted small-business threshold ($30 million in 2024). Most small businesses are exempt.
Auto loan interest
Interest on a vehicle loan is deductible only for the business-use portion of the vehicle. Standard mileage method already includes a fuel/maintenance/depreciation allowance but does NOT include loan interest — loan interest is separately deductible even when using the standard rate, prorated by business-use percentage.
Credit card interest
Interest on a credit card used exclusively for business purchases is deductible. Interest on a personal credit card used for occasional business charges is harder to allocate — separating business spending onto a dedicated business card greatly simplifies the deduction.
Where it goes
Schedule C line 16a ("Mortgage interest") for business-property mortgage interest paid to a financial institution. Line 16b ("Other interest") for everything else — credit cards, business term loans, equipment financing, vehicle loans (business portion).
Worked example with numbers
Consider a sole prop with $100,000 in gross receipts and $30,000 in legitimate Schedule C deductions, including this category. Each additional $1,000 of qualifying expense reduces Schedule C net profit by $1,000, which reduces self-employment tax by approximately $1,000 × 92.35% × 15.3% ≈ $141, and reduces income tax by $1,000 × marginal rate. At a 22% federal marginal rate, the combined federal tax savings on each additional $1,000 of legitimate deduction is roughly $361, and state savings sit on top of that. The math is why disciplined categorization throughout the year pays for itself.
Common mistakes that disallow the deduction
The recurring ways this deduction gets disallowed in examination cluster in four categories: (1) personal-use expenses bundled with business (the deduction is disallowed entirely or apportioned downward); (2) inadequate substantiation (no receipt, no invoice, no business-purpose note); (3) the wrong line on Schedule C (not fatal, but it weakens audit defense); and (4) double-counting with another line (for example, deducting an expense on Schedule C and also on Form 8829, or as a personal itemized deduction on Schedule A). The fix in every case is contemporaneous bookkeeping and a clean chart of accounts.