Personal Interest vs. Investment Interest in 2025: Tracing Rules and Temporary Vehicle-Loan Carve-Out

The IRS distinguishes between personal interest—generally nondeductible—and investment interest—potentially deductible when tied to income-producing assets. The key lies in the use of the borrowed funds, not just the label on the loan. This is where the IRS “tracing rules” come into play.

In 2025, the rules remain strict: most consumer debt (like credit cards, auto loans, and personal lines of credit) falls under personal interest. However, if funds are properly traced to investments, part of the interest may qualify as deductible investment interest.

🔎 What is Personal Interest?

Personal interest includes expenses unrelated to business or investment activities. These remain nondeductible for individuals:

• Credit card interest for personal spending
• Mortgage interest on loans not qualifying as “home acquisition debt”
• Auto loan interest (unless tied to a deductible carve-out)
• Personal loan and consumer financing interest

💹 What is Investment Interest?

Investment interest is interest paid on debt used to purchase taxable investments such as:

• Margin loans used to buy stocks or bonds
• Loans used to acquire real estate held for investment
• Borrowing to invest in partnerships or LLCs

The deduction is limited to net investment income and reported on Form 4952, Investment Interest Expense Deduction. Excess interest may be carried forward.

📌 IRS Tracing Rules Explained

Under IRS tracing rules, the tax treatment of interest depends on how the borrowed funds are used:

• If funds are used to buy investments → Interest is investment interest.
• If funds are used for personal consumption → Interest is personal and nondeductible.
• If funds are mixed (part investment, part personal) → Interest must be allocated proportionally.

Accurate recordkeeping is critical. The IRS may disallow deductions without proof of fund usage.

🚗 Temporary Vehicle-Loan Carve-Out

For 2025, Congress extended a temporary carve-out allowing certain vehicle loan interest to qualify as deductible if the vehicle is used predominantly for income-producing activities (e.g., real estate agents or gig workers investing in delivery/rideshare operations).

• Must demonstrate over 50% business/investment use
• Interest portion allocated to investment/business is deductible
• Remaining personal use portion remains nondeductible

Taxpayers should keep detailed mileage logs and loan statements to support claims in case of an audit.

⚠️ Common Audit Pitfalls

• Failing to properly trace loan proceeds to investments
• Claiming personal credit card or auto loan interest as deductible
• Not using Form 4952 when required
• Overstating business use of a vehicle to capture the carve-out

The IRS frequently audits taxpayers who incorrectly classify personal interest as investment interest. Proper documentation is your best defense.

💡 Tax Planning Tips for 2025

• Keep clear records of how borrowed funds are used.
• Consider separating loans: one for personal use, one for investments.
• Maximize the vehicle-loan carve-out only if you have strong records.
• Consult IRS Publication 550 for investment income guidance.

🔑 Key Takeaways

• Personal interest remains nondeductible for most individuals.
• Investment interest is deductible up to net investment income, with carryforward allowed.
• IRS tracing rules determine deductibility based on use of funds.
• The 2025 temporary vehicle-loan carve-out provides opportunities but requires strong recordkeeping.