Are Loan Payments Deductible?

Human holding a large stack of coins in one hand and a smaller stack in the other.

Many business owners wonder, are loan payments deductible? You might think that every dollar you send to the bank to pay off your business loan is a business expense, right? Well, not quite! In reality, only the interest portion of those business loan payments are deductible. Here’s why. When you take out a loan to finance your business ventures, whether it’s purchasing the business, buying equipment, financing expansion, or whatever else you need, you’re borrowing money that you’ll eventually have to pay back, along with some extra for the privilege of borrowing (that’s the interest).

Your monthly business loan payments are split into two parts: principal and interest. The principal is the actual amount you borrowed, and the interest is the fee the lender charges you for the privilege of borrowing that money. So, here’s why only the interest portion of your loan payments is considered a business expense:

  • Interest is the Cost of Borrowing: Think of interest as the cost of using someone else’s money. Just like you pay rent for using someone else’s property, you pay interest for using someone else’s money. And just like rent is a business expense, so is the interest you pay on your business loans.
  • Principal Repayment Isn’t an Expense: On the other hand, the principal portion of your loan payment isn’t considered a business expense because it’s not money you’re spending on goods or services to keep your business running. Instead, it’s money you’re using to pay off the amount you borrowed in the first place.
  • Accounting Rules Matter: From an accounting perspective, only the interest portion of your loan payments gets recorded as an expense on your income statement. The principal repayment, on the other hand, gets recorded as a reduction in your liabilities on your balance sheet since it’s money you owe that’s being paid off.

So, let’s break it down with an example. say you have a monthly loan payment of $1,000, with $800 going toward the principal and $200 toward interest. In this case, you’d only record the $200 interest portion as a business expense in your books. The $800 principal repayment doesn’t get expensed since it’s not considered a cost of running your business.

While the principal portion of your loan payments isn’t considered a business expense, it does have an impact on your cash flow. As you pay down the principal, your debt decreases, which means you have more money available to reinvest in your business or use for other purposes down the line.

Understanding the distinction between business loan principal and interest is key to keeping your books accurate, which will then give you a more accurate picture of your business finances.

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Gwen Harrison President

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