The tax rules applicable to the business automobile are very complex. In this post, I’ll present several ideas to maximize your business automobile deductions.
Maximizing Your Daily Deductions Use two cars for business to get maximum deductions: If you drive only one car for business, the maximum business-use percentage you can achieve is 100%. If you drive two cars for business, you could drive each car 80% for business and increase your effective maximum business-use percentage to 160% Your business-use percentage is based on business miles driven. First Step: Figure your business use by dividing business miles by total miles driven. Do this for each car driven for business.
Business Use Calculation
|Total Mileage for Year||25,000||20,000||8,000|
|Business Use Percentage||0.92%||0.88%||0.69%|
|Gas & Oil||2,880||2,191||689|
|Repairs & Maintenance||800||800||600|
|Tags & Licenses||100||100||100|
|Wash & Wax||230||230||230|
|Total Operating Expense||4,860||4,171||2,269|
|Business Use Percentage||0.92||0.88||0.69|
|Depreciation(basis for each car is $22,000)||2,024||1,925||1,375|
Extra Deduction for 2 cars: 5,595 + 2,941 – 6,495 = 2,041
Note: Additional expenses may be deductible under both the IRS and Actual Methods to the extent the automobile(s) is/are used for business.
Caution! Using two cars for business deductions puts extra money in your pocket only when you are converting an otherwise personal asset to business use. In other words, if you have two cars in your family, make them both deductible, but don’t buy a second car just for the business deductions.
Caution! One disadvantage of using two cars in a business or bringing another car into your business during the year is that you must keep track of your mileage on a daily basis. The “sampling techniques” mentioned below can not be used.
Figuring out the depreciation expense: You are allowed to depreciate the “basis” of your car. Because the car was used for personal purposes, you determine basis on the day you convert the car to business use. On that day, you determine “basis” by comparing cost and market value of the car and using the lower of the two.
1) Cost: As used here, cost is what you paid for the car originally plus capital improvements such as amounts spent to rebuild or replace an engine.
2) Market Value: Market value is the fair market value of the automobile on the day you convert it to business use. Generally, you can determine market value by referring to the “blue book”: The National Automobile Dealer’s Association Official Used Car Guide. The blue book lists two values for used cars: (1) retail and (2) wholesale. Since you will use the blue book’s value for determining depreciation, you want the highest number – the retail price. That’s what you would have to pay to purchase the car and what a regular customer would have to pay to a dealer. It’s also the number that gives you the most depreciation.
Example: Assume you purchased your personal car several years ago for $18,000. Today, that car has a retail book value of $15,000. Your basis for purposes of computing depreciation is $15,000 (the lower of cost or fair market value.)
Deduct the larger of the actual expense deduction or the IRS optional mileage rate deduction: Unlike corporations, individuals such as the self-employed, have a choice. They can use either IRS optional mileage rates or the actual expenses to deduct business automobile expenses. 2014 rates. The 2014 IRS optional mileage rates are:
- 56 cents for business miles
- 23.5 cents for medical and moving
- 14 cents for charitable activities
The IRS standard mileage rate has a depreciation component built into its rate of 56 cents per mile.
- 22 cents for depreciation
- 34 cents for operating expenses
Each 56 cents-a-mile deduction reduces the basis of your business car by 22 cents. Thus, if you drove 25,000 miles, your depreciation for the year would be $5,500, and that reduces your basis by that amount, but not below zero.
Finding The Largest Deduction For Your Automobile: In order to find the largest deduction for auto expenses, simply compare the deduction based on actual expenses to the deduction allowed using the IRS mileage rates.
|Deduction based on Actual Expenses(From Table Above)||6,495||5,595||2,941|
|IRS Business mileage rate||0.565||0.565||0.565|
|Deduction based on IRS mileage rate||12,995||9,888||3,108|
|Largest Deduction is obtained from using:||IRS mileage rate||IRS mileage rate||IRS mileage rate|
In this example, the deduction calculated from the IRS mileage rates results in a larger deduction for both the 1-car scenario and the 2-car scenario, so you would choose to use the IRS mileage rates. Every case is different, so you will need to do the calculations based on your car and your business usage in order to determine which way is better for you.
Switch to actual allowed: If you currently use IRS rates, you may switch to actual.
Switch to IRS mileage rate: Generally, you may not switch from the actual method to the IRS allowance unless straight line depreciation has been used from the beginning.
Select the fastest depreciation method to obtain maximum annual deductions: Depreciation is nothing more than the allocation of costs over more than one year; therefore, pick the method that gives you the largest deduction each year.
Depreciation methods available: There are two basic depreciation methods for business automobiles: straight-line and accelerated. Today’s tax law further complicates matters by placing “luxury car” limits on depreciation. The accelerated rate (MACRS), straight-line rate, and luxury limits for passenger cars for 2013 are:
|Year||MACRS||Straight line||Luxury Limit|
Bonus depreciation: For 2013, an extra bonus depreciation deduction of up to $8,000 may be taken for luxury automobiles and light trucks, light vans or light SUVs purchased new in 2013. This deduction is in addition to the allowable normal luxury automobile depreciation limits.
Example: You purchase a $40,000 car and use it 75% for business. The personal use reduces your deductions. Depreciation deduction possibilities and the luxury limit for the first year are:
- $6,000 under MACRS ($40,000 x 20% x 75%)
- $3,000 under S-Line ($40,000 x 10% x 75%)
- $8,370 under the Luxury Limit ($11,160 x 75%)
The maximum 1st year depreciation you can claim is $11,160, including “bonus depreciation,” because of the luxury limit.
Light vans, SUVs, and trucks: If a vehicle’s unloaded gross vehicle weight is 6,000 pounds or less and it is considered a light van, SUV or truck, then it is subject to luxury automobile depreciation limits for light vans, SUVs and trucks. If the light van, SUV or truck was placed in service in 2013, then depreciation is limited to the following amounts:
- 1st year in service (2013) – $3,360
- 2nd year in service (2014) – $5,400
- 3rd year in service (2015) – $3,250
- 4th year in service and after (2016 and on) – $1,975.
Heavy SUVs: If an SUV’s (or truck with a bed less than six feet in length) gross vehicle weight is more than 6,000 pounds, no luxury automobile depreciation limits are placed on that vehicle, but the §179 deduction that may be taken is limited. A §179 deduction may be taken for up to $25,000 of the purchase price (subject to certain §179 limitations). Bonus depreciation may also be taken for 50% of the vehicle’s remaining basis (after reducing the basis for any §179 deduction taken), if the vehicle is purchased new. In addition, normal MACRS depreciation may be taken on the basis remaining after application of the bonus depreciation and §179 deductions.
Special Note: RVs and cars that weigh over 6,000 pounds are exempt from limits, Electric cars can deduct three times the luxury car limits.
Leasing vs. Buying Non-Tax Leasing Advantages: Leasing is good if you meet a few of the underlying criteria:
- Your financial income does not vary from year to year.
- It is important to drive a new vehicle in your business.
- You don’t like to own the same cars for more than a couple of years.
- You generally drive less than 15,000 miles per year.
- Your credit rating could use some improvement.
- You hate auto repairs and dislike leaving your car at the shop.
- You are an employee who uses a car for business and don’t have the money to purchase the car with cash.
It is better to buy when:
- You pay all cash or get great finance terms such as 0% interest, or
- You keep the car for 4 years or more, or
- The auto weighs more than 6,000 pounds, or
- You put on more than 15,000 miles per year.
Buy cars, don’t lease them, to obtain the best after-tax return on your car investment: The after-tax cost is greater to lease than to purchase both business and personal cars. We have run the numbers in detail and found that it costs about 10% more to lease than to purchase.
Lease inclusion for luxury cars: If the 2013 fair market value of the leased business car is greater than $18,999, you must add to your taxable income an “inclusion amount” from an IRS table found in IRS Publication 917. The inclusion amount is designed to produce a lease payment benefit equal to the benefit you would otherwise receive from a deduction for depreciation.
Identify supplies and equipment used to maintain your business car: Take a trip through your garage and basement, or wherever you store tools and cleaning supplies. Make a list of the items you use on your car. You will probably find a battery charger, battery cables, and maybe even a battery tester. You might find a tire pump, a vise, a buffer, and a sander. By the time you get to the small tools such as screwdrivers, pliers, and wrenches, you should have found a number of items whose cost you have overlooked. Since you will be backtracking through past acquisitions, it’s likely you won’t have receipts. Take photographs which can represent reasonable substitute evidence. The reconstruction method requires a reasonable basis for the reconstruction: You may reconstruct records that you don’t have (with some exceptions such as having receipts for charitable contributions of $250 or more). The key is that there must be a reasonable basis for the reconstruction. You can’t use the, “finger in the wind” technique.
Depreciate items with cost in excess of $250: If an item has an original cost in excess of $250, it should be capitalized and depreciated. If the cost is less than $250 for an individual item or a group of small tools, it’s normal to expense such items in the year of purchase.
Maximum Dollar Benefits When You Dispose Of Your Current Business Car
Computing Gain or Loss on Disposition of Auto
|Total Miles||Business Miles||Personal Miles|
|Percentage Business/Personal Use||100%||83.3%||16.7%|
|Depreciation to date of sale||$15,656||N/A|
Note how computations are made for both personal and business use.
Sell cars that produce deductible losses, but trade cars that produce taxable profits.
Computing basis after a trade: When you trade your old car for a replacement, you take the old depreciated basis and add cash boot to determine the new basis for depreciation.
Example: You give the dealer $10,000 plus your old 80% business use car to obtain the replacement car. Your basis in the old car is $2,000 for business and $2,400 for personal. For depreciation purposes, your business basis in the replacement car is $8,000 cash boot plus $2,000 from the old business basis for a total of $10,000.
Sell cars on which you claimed IRS mileage rate deductions because such cars usually have a high basis: Do you use IRS rates and trade cars? If so, you could be looking at a tax windfall this year. The low depreciation with IRS rates produces a high basis which you continue to build when you trade cars.
Example: Bob purchased his first business car in 2004 for $25,000. He drove that car 40,000 miles and traded it for a new car in 1982. Every two years thereafter he traded cars and gave the dealer $12,000.
|2004||$25,000||Cash paid for new car|
|2006||$12,000||Cash boot paid with trade|
|2008||$12,000||Cash boot paid with trade|
|2010||$12,000||Cash boot paid with trade|
|2012||$12,000||Cash boot paid with trade|
|$73,000||Total cash paid for cars|
Bob claimed his car deductions using the IRS mileage rate method. His total annual mileage each year is 20,000. Because Bob traded cars, he never recognized gain or loss. By selling his car out right now, Bob can claim a loss deduction of $32,340.
Depreciation claimed with IRS mileage rate use in prior years:
|Year||Business||Personal||Total||Allowable Miles||Mileage Rate||Basis Reduction|
Calculation of deductible loss on sale:
|Original cost & cash boot||$73,000||$18,250||$54,750|
|Loss on sale||N/A||($14,250)||($10,130)|
Personal losses are not deductible: If you sell a personal car at a loss, the loss is not deductible. The $14,250 Bob lost on the personal portion of his automobile sale is not tax deductible.
Personal profits are taxable: If you sell a personal car at a gain, the gain is taxable.
Automobile Deductions Summary
- Use 2 cars for business and keep a year-long daily auto log.
- Convert personal cars to business use.
- Pick the greater of actual expenses or IRS mileage rate deductions.
- Select fastest depreciation method.
- Buy rather than lease cars.
- Identify and deduct supplies and equipment used with your business car.
- Sell cars that produce deductible losses, but trade cars that produce taxable profits.
- Sell cars on which you claimed IRS rates.