Who this is for
- Sole proprietors, partnerships and corporations that borrowed from a bank or other lender for the business
- Owners whose whole loan payment is coded to one expense account
- Owners who financed a vehicle or equipment, with or without a trade-in
- Businesses with loan fees, points or a forgiven balance to record
Not covered here
- Loans from an owner, partner, shareholder or relative
- Venture debt with warrants
- Credit card balances and card payments
- The statements a lender asks for before it lends
- State income tax rules
- Choosing between depreciation methods
How do I enter a business loan in the books?
A business loan is a liability, not income. When the money arrives, cash goes up and the loan balance goes up by the same amount, so the P&L does not move. A loan not entered this way leaves profit wrong, and a lender or a tax return may already have used that figure. The IRS says money borrowed through a bona fide loan is not income. Whether a loan is bona fide is tested on the facts, which is where loans with no paperwork, or from an owner or relative, run into trouble.
The journal entry is a debit to the bank account and a credit to a loan account for that lender. Term, equipment, SBA and line-of-credit loans are entered the same way. When the lender pays someone else at closing, debit what was bought instead of the bank account.
| Piece of the loan | In the books | On the return |
|---|---|---|
| Money received | Cash up, loan balance up | Not income |
| Interest in a payment | Interest expense on the P&L | Business interest if the money was used in the business; a limit can apply |
| Principal in a payment | Lowers the loan balance; never on the P&L | Not deductible |
| Fees and points to get the loan | Generally spread over the loan term | Generally deducted over the term |
| Vehicle or equipment bought with the loan | Asset at full cost | Depreciated; financing does not change that |
| Forgiven amount | Loan balance removed, gain recorded | Generally income unless an exception or exclusion applies |
The entries are the same for a sole proprietor, a partnership and a corporation; only the return line that carries the interest differs. A case is not simple when payments were already coded to expense in a closed or filed year, part of the money paid for personal spending, a trade-in, fees or a forgiven balance are involved, the loan is in your own name while the business uses the money, or the lender is an owner, partner or relative.
Gather: the loan agreement, the lender's amortization schedule, every lender statement since the loan began, the closing statement, the purchase invoice for anything financed, and the bank statement showing the deposit.
How do I split a loan payment into principal and interest?
Use the lender's schedule. With no schedule, ask the lender for one, or use the interest and principal shown on each statement. Each payment on an amortizing loan has an interest part, figured on the balance still owed, and a principal part, which is the rest. Interest is largest in the first payments and shrinks as the balance falls. Record each payment as one entry with three lines:
| Account | Debit | Credit |
|---|---|---|
| Interest expense | Interest part | |
| Loan balance (liability) | Principal part | |
| Bank account | Full payment |
Accounting software shows the payment as one withdrawal. The only decision is its category: split it between the interest expense account and the loan account. Coding the whole withdrawal to an expense category is the mistake that overstates expenses.
- The schedule, not a formula, controls. Payment dates, day counts, rate changes, extra payments and an interest-only period shift the split. Absent a different understanding between the parties, the IRS applies a partial payment first to interest and the remainder to principal (Publication 535).
- Other lender charges are neither. Escrow, late fees and annual fees get their own accounts.
- A line of credit works the same way. Each draw raises the balance; each payment lowers it by its principal part.
Because principal never reaches the P&L, profit can look healthy while cash falls: see profit with no cash in the bank.
Which part of a loan payment is deductible, and what limits apply?
Only the interest part, and only to the extent the borrowed money was used in the business. Principal repays money already received; for a partial payment the IRS allows a deduction for the interest, not the remainder (Publication 535). Three tests apply to the interest:
- Use of the money. Interest follows how the proceeds were spent, not what secures the loan. A loan secured by business property but spent on a personal car produces personal interest. When one loan paid for business and personal spending, the interest must be divided (Publication 334). A separate account for the proceeds makes tracing easier.
- A real debt. The borrower must be legally liable, both sides must intend repayment, and they must have a true debtor-creditor relationship (Publication 535, a discontinued IRS publication whose last edition stays online).
- The section 163(j) limit. A business is generally outside the cap if it is not a tax shelter and its average annual gross receipts for the 3 prior tax years are $32,000,000 or less. Receipts of related businesses are added together, and an owner of a partnership or S corporation counts a share of its receipts. A real property or farming business can instead elect out; the election is irrevocable and requires the alternative depreciation system for certain property, so it belongs with the preparer. Other businesses can deduct business interest only up to their business interest income, plus 30% of adjusted taxable income, plus floor plan financing interest. Disallowed interest carries forward, and Form 8990 reports the limit and the carryforward (section 163(j); Form 8990 instructions).
Two more rules apply. A cash-method business deducts interest when paid, an accrual-method business as it accrues, and prepaid interest only in the year it is due. Interest on a loan used to produce real property or certain other long-lived property may have to be added to that property's cost instead, unless the business is a small business taxpayer (Publication 535).
| Business type | Where business interest goes | Watch for |
|---|---|---|
| Sole proprietor | Schedule C line 16a for a business mortgage with a Form 1098; line 16b for other interest | The personal share of a mixed-use loan |
| Partnership | Form 1065 line 15 | Debt used for rentals, investments or partner distributions is reported elsewhere |
| S corporation | Form 1120-S line 13 | The same exceptions: rentals, investments and shareholder distributions |
| C corporation | Form 1120 line 18 | An interest allocation when proceeds had more than one use |
Line numbers can move from one form year to the next.
What if I booked the whole loan payment as an expense?
Profit is too low by the principal portion, and the loan balance in the books is too high. By the end of the loan, the principal expensed equals the amount borrowed. The fix moves principal out of expense and into the loan balance:
- From the lender's schedule and statements, list the principal in every payment since the loan began, and total it by year.
- In the open year, post one entry for that year's principal: debit the loan balance, credit the expense account the payments were coded to.
- For earlier years, work out each year's correction on a schedule before posting anything. It changes that year's profit and the equity the next year opens with, so the books will no longer match the return as filed (retained earnings that do not match last year's return).
- Confirm the loan balance in the books now equals the lender's balance on the same date.
Principal is not deductible, so a filed return that deducted whole payments may have claimed more than the rules allow. Whether to amend depends on the year, the amounts and the entity. A self-employed owner can start with amending a return for business expense mistakes. A partnership or S corporation whose K-1s went out should read correcting a filed business return.
How do I record a vehicle or equipment bought with a loan?
Record the asset at its full cost and the loan at the amount borrowed. Cash falls only by what was paid at signing. Cost is what is paid in cash, debt obligations, other property or services, plus items such as sales tax, freight and installation (Publication 551; Publication 946). An owner who buys property subject to a debt is treated as its owner and can depreciate it (Publication 946).
Each later payment is interest expense plus a lower loan balance. It is never a "truck payment" expense and never added to the asset's cost. Depreciation, or a first-year deduction where one applies, recovers the cost: see writing off equipment in the first year.
Interest on a vehicle used partly for personal driving. A self-employed owner can generally deduct the business-use share of the interest on Schedule C, even when using the standard mileage rate (Publication 334; Publication 463). The personal share stays off the P&L. When a corporation or partnership owns the vehicle, the entity pays the interest, and an owner's personal driving is a separate pay or distribution question: see buying a vehicle through your business.
A trade-in. When the allowance is close to the old vehicle's market value, the books show the new vehicle in at its contract price and the old vehicle out at cost less accumulated depreciation, with any gap to the allowance booked as a gain or loss. If the dealer's price and allowance both look inflated, the cost and gain need the preparer. For tax, an ordinary vehicle trade-in is a sale of the old vehicle and a purchase of the new one, because like-kind exchange treatment now covers only real property (26 U.S.C. 1031; Publication 544), even though Publication 463 still shows older trade-in text. Give the preparer the old vehicle's tax basis, depreciation history, business-use records and the trade-in contract to work out the tax gain or loss and the new vehicle's tax basis.
Are loan fees and points deducted right away?
Generally no. Most charges for getting a loan are spread over its term. Points, also called origination fees or discount points, are prepaid interest and are generally not deductible in full in the year paid (Publication 535). For a loan on business property, Publication 551 says a credit report and a lender-required appraisal are capitalized as costs of getting the loan and deducted over the loan's period, and that points are generally deducted over the term. Under the regulation, debt issuance costs, meaning transaction costs that must be capitalized, are deducted over the term as if they lowered the loan's issue price (26 CFR 1.446-5). A related regulation treats up to $5,000 in total of costs of pursuing a borrowing, other than employee compensation and overhead, as not needing capitalization; commissions never count, and above that total none of it does (26 CFR 1.263(a)-5). Publication 551 does not mention that rule, so whether small costs, apart from points, are deducted when paid is a question for the preparer.
In the books, record fees as a deferred financing cost and move a slice into interest expense each month. When the lender takes charges out of the proceeds, the deposit is net but the loan balance is the full amount. A discount or points taken out of the proceeds are not interest paid when the loan is received (Publication 535), and follow the over-the-term rule above. Other charges follow the rules above for their kind: taking a charge out of the proceeds does not by itself decide when it is deductible. If the loan ends early, the remaining unamortized fees and points may be deductible that year, but refinancing with the same lender generally moves them into the new loan's term.
What if part of the loan is forgiven or cancelled?
When a third-party lender forgives part of the balance, remove it and record a gain in the same entry. If the lender is an owner, partner or shareholder, the forgiveness is usually a contribution instead, though a corporation can still have cancellation income when the debt exceeds the owner's basis in it: see owner contributions and loans to an LLC. For tax, a debt cancelled for less than the amount owed is generally taxable in the year of cancellation unless an exception or exclusion applies (Topic 431).
- Exceptions come first. For a cash-method borrower, cancelled unpaid interest that would have been deductible if paid is not income, but cancelled principal gets no such relief (26 U.S.C. 108(e)(2)). A seller's qualified price reduction on property you bought from that seller is not income and needs no attribute reduction (Topic 431).
- Exclusions include debt cancelled in a bankruptcy case, to the extent the borrower was insolvent, qualified farm debt and, for a borrower that is not a C corporation, qualified real property business debt. An excluded amount generally reduces tax attributes such as loss carryovers and asset basis, reported on Form 982 (Publication 4681). The real property exclusion is an election: check Form 982 line 1d on a timely filed return, including extensions. A timely filer who left it out can generally still elect on an amended return filed within 6 months after the return's unextended due date (Form 982 instructions).
- Paycheck Protection Program loans. Forgiveness of a covered loan was excluded from gross income by its own statute, not by section 108, so it is a gain in the books but not income on the return (Rev. Proc. 2021-20). Other relief programs have their own rules.
- Form 1099-C. A covered lender that cancels $600 or more after an identifiable event must file it, whether or not the borrower has to report the income (instructions). If the lender keeps collecting, the debt may not be cancelled. The borrower reports the correct amount whatever the form says.
- Repossession or foreclosure. A creditor that takes the property securing a debt is treated as buying it, which gives a gain or loss on the property. A debt the borrower is personally liable on can also give cancellation income; a nonrecourse debt does not (Topic 431).
- Partnerships and S corporations. The exclusions, and the real property election, apply at the partner level for a partnership (each partner elects) and at the corporate level for an S corporation (26 U.S.C. 108(d)).
How do I check the loan balance each month?
Compare the loan balance in the books with the lender's statement balance on the same date, then confirm interest plus principal equals the payment. The IRS advises reconciling the business checking account monthly (Publication 583).
| Check | What should match |
|---|---|
| Balance | The books' loan balance equals the lender's balance on the statement date |
| Interest | The interest in each payment matches the statement; book interest expense differs only by a personal share, deferred fees or accrual timing |
| Principal | Opening balance, plus draws, less principal paid, equals the closing balance |
| Cash | The bank reconciliation shows the full payment cleared |
| Year end | The year's interest on the lender's statement, with the same adjustments, equals the interest expense |
A mortgage lender generally sends Form 1098 when interest and certain points reach $600 or more in a year (Publication 535). The form covers interest received from an individual, including a sole proprietor, so a partnership or corporation relies on the lender's year-end statement (Form 1098 instructions). If the lender is a private person or other non-corporate lender, the business may owe that lender a Form 1099-INT once a year's interest reaches $2,000; a corporate lender is exempt (26 U.S.C. 6041; Form 1099-INT instructions). Common causes of a gap are a payment that cleared across month end, an extra principal payment, a fee or escrow amount coded as principal, or a draw on a line of credit that was never booked. A balance that will not tie also shows up in a balance sheet that looks wrong.
Example
These examples are illustrative and use US dollars.
A term loan: only the interest hits the P&L
A business borrows $100,000 at 8% over 5 years, with equal monthly payments of about $2,028. On receipt, the bank account is debited $100,000 and the loan is credited $100,000. The P&L does not change.
In month one, interest is about $667 ($100,000 × 8% ÷ 12) and principal is about $1,361. The entry debits interest expense $667 and the loan $1,361, and credits the bank $2,028. In month two, interest is about $658 and principal about $1,370, because interest is figured on a smaller balance. After twelve payments, the year's interest is about $7,388, principal is about $16,944, and the loan balance is about $83,056. Only the $7,388 reaches the P&L.
A truck bought with a down payment, a loan and a trade-in
A self-employed owner buys a truck for $60,000 with $10,000 down and a $50,000 loan. The entry debits the truck $60,000, credits cash $10,000 and credits the loan $50,000. At 7%, the first month's interest is about $292. The truck is used 80% for the business, so about $233 is business interest expense and about $58 is personal, kept off the P&L.
Now the same $60,000 truck bought with a trade-in. The old truck cost $30,000 and has $20,000 of accumulated depreciation in the books. The dealer allows $12,000 for it, about its market value, and the owner pays $8,000 cash and borrows $40,000.
| Account | Debit | Credit |
|---|---|---|
| New truck | $60,000 | |
| Accumulated depreciation, old truck | $20,000 | |
| Old truck, at cost | $30,000 | |
| Bank account | $8,000 | |
| Loan | $40,000 | |
| Gain on the trade-in | $2,000 |
The books' gain is the $12,000 allowance less the old truck's $10,000 book value. The tax gain or loss uses the old truck's tax basis, which can differ.
Every payment booked as an expense
Take the first loan. All twelve payments of about $2,028 are coded to an expense account, so about $24,332 is expensed. Only about $7,388 was interest. Expenses are overstated by about $16,944 and profit is understated by the same amount: books showing a $30,000 profit should show about $46,944. The balance sheet still shows the loan at $100,000 while the lender shows about $83,056, and the gap widens each year. If that year is still open, debit the loan $16,944 and credit the expense account $16,944 to correct it.
Different for you?
- Payments were expensed in full for a year or more, or a filed return used the wrong profit: the correcting entries, whether a return changes and the right opening loan balance need professional judgment. Start with amending a return for business expense mistakes or correcting a filed business return, and get bookkeeping help.
- One loan paid for business and personal spending: the interest must be traced and divided, and the personal share taken out of the books. Get bookkeeping help to rebuild the split from the statements.
- Fees, forgiveness or a trade-in complicate the entry: the book entry and the tax treatment can differ. Get bookkeeping help before posting, and read buying a vehicle through your business if the business owns the vehicle.
- An owner, partner or shareholder lent the money, or the loan is in your own name and the business uses it: the business may not be the borrower, so interest and repayment are booked differently. See owner contributions and loans to an LLC or shareholder loans to an S corporation, and get bookkeeping help to sort out what was lent and what was contributed. For a relative's loan with no paperwork, see a family loan to your business.
- The loan is venture debt with warrants, or the balance is on a credit card: see venture debt and warrants or credit card payments in the books.
- A bank wants statements before lending, or the books are months behind: see financial statements for a bank loan or catching up on overdue books, and get bookkeeping help to bring the loan account up to date.
Figures on this page
| Figure | Value | Source |
|---|---|---|
| Section 163(j) small business taxpayer gross receipts limit Average annual gross receipts for the 3 tax years before the current one, for tax years beginning in 2026. Section 163(j)(3) uses the section 448(c) gross receipts test, so this is the same inflation-adjusted figure; a tax shelter does not qualify, and receipts of related businesses are aggregated. | $32,000,000 Tax year 2026 | IRS: Rev. Proc. 2025-32, section 4.30 (Internal Revenue Bulletin 2025-45) Checked |
| Section 163(j) adjusted taxable income component of deduction limit Business interest income and floor-plan financing interest are additional components; exception and other deduction restrictions may apply | 30% Tax year 2026 | IRS: Business interest limitation questions and answers Checked |
| De minimis limit on costs of pursuing a borrowing Total of amounts paid in the process of investigating or otherwise pursuing a borrowing, other than employee compensation and overhead; above the limit none of the amounts qualify. Commissions are not de minimis costs. The regulation allows a greater amount set in published guidance. | $5,000 | eCFR: 26 CFR 1.263(a)-5(d)(3) Checked |
| Late election window for qualified real property business debt exclusion A taxpayer who filed on time without the Form 982 line 1d election (or the section 108(b)(5) election) can make it on an amended return filed within this period after the return's due date, excluding extensions; write "Filed pursuant to section 301.9100-2" on it. | 6 months | IRS: Instructions for Form 982, When To File Checked |
| Form 1099-C cancelled debt reporting threshold A covered lender files Form 1099-C for each debtor when a debt of this amount or more is cancelled after an identifiable event, whether or not the debtor must report the cancelled debt as income. | $600 | IRS: Instructions for Forms 1099-A and 1099-C Checked |
| Form 1098 mortgage interest reporting threshold, per mortgage Mortgage interest, including points, received from an individual in the course of a trade or business; applies separately to each mortgage | $600 | IRS: Instructions for Form 1098 Checked |
| Form 1099-INT threshold for other interest paid in the course of a trade or business (section 6041) 26 USC 6041(a) as amended by Pub. L. 119-21; indexed for calendar years after 2026. The 1099-INT instructions (rev. 01/2024) still print $600 | $2,000 Tax year 2026 | US Code: 26 USC 6041 Checked |
Primary sources
- IRS: Publication 334, Tax Guide for Small Business
- IRS: Publication 535, Business Expenses, chapter 4, Interest (last edition, discontinued)
- IRS: Guide to business expense resources
- IRS: Instructions for Form 8990
- US Code: 26 U.S.C. 163, interest
- IRS: Rev. Proc. 2025-32, inflation adjustments for 2026 (Internal Revenue Bulletin 2025-45)
- IRS: Publication 551, Basis of Assets
- IRS: Publication 946, How To Depreciate Property
- IRS: Publication 463, Travel, Gift, and Car Expenses
- IRS: Publication 583, Starting a Business and Keeping Records
- eCFR: 26 CFR 1.446-5, debt issuance costs
- eCFR: 26 CFR 1.263(a)-5, amounts paid to facilitate certain transactions
- IRS: Instructions for Form 1098
- IRS: Instructions for Schedule C (Form 1040)
- IRS: Instructions for Form 1065
- IRS: Instructions for Form 1120-S
- IRS: Instructions for Form 1120
- IRS: Topic no. 431, Canceled debt
- IRS: Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments
- IRS: Instructions for Forms 1099-A and 1099-C
- US Code: 26 U.S.C. 108, income from discharge of indebtedness
- IRS: Rev. Proc. 2021-20, forgiveness of Paycheck Protection Program loans
- IRS: Instructions for Form 982
- IRS: Publication 544, Sales and Other Dispositions of Assets
- US Code: 26 U.S.C. 1031, exchange of real property
- US Code: 26 U.S.C. 6041, information at source
- IRS: Instructions for Forms 1099-INT and 1099-OID
About this guide
Published by Cloud Accounting under standing professional approval. This version has no separately recorded personal review. It explains general rules for the tax year shown. It is not advice for your situation.
Changes
- : First published.