If you own a business or are a sole proprietor, a vehicle expense can be deducted from your income to lower your tax bill. This article discusses how much of a vehicle expense you can deduct and not get in trouble with the IRS.
I strongly believe a car is the #1 personal finance killer because people spend too much of their income on a depreciating asset. Follow the 1/10th rule for car buying if you want to grow your net worth.
With cars being so expensive, it's logical to want to try and deduct some of its expense, especially if you are a freelancer (1099 income) or a small business owner (S-Corp or LLC). Here are some common questions you might have.
How Much Vehicle Expense Can You Deduct
Q – Should my business buy my car/vehicle?
A – No. Buy the vehicle in your name (not the business) and pay for it with non-business money. The main reason is because company-owned vehicle insurance is much more expensive than individual car insurance.
Q – If my business isn’t buying the vehicle, how do I get the deduction?
A – At the end of each month you will submit an expense report to your business and it will reimburse you through mileage or actual financial costs.
When your business reimburses you, your business claims the reimbursement as a deduction, reducing the amount of business income that is taxable, which in turn reduces your overall taxes. The reimbursement you receive from your business is not taxable to you – it is tax free income.
Q – What information do I need to track for my vehicle?
A – You’ll want to track how many business miles versus total miles you put on your car in a year. Your business miles divided by your total miles is your percentage of business use.
This is a very important percentage because it is the percentage of your vehicle expenses for which you can be reimbursed by your business. You will be submitting your mileage each month on an expense report.
Beginning on Jan. 1, 2017, the standard mileage rates for the use of a car (also vans, pickups or panel trucks) will be: 53.5 cents per mile for business miles driven, down from 54 cents for 2016. 17 cents per mile driven for medical or moving purposes, down from 19 cents for 2016
Q – Should I buy or lease my vehicle?
A – Whether you buy or lease has more considerations than just taxes. For example, most leases limit the amount of miles you can drive each year. However, there are some important tax considerations to consider in the “buy vs lease” decision.
When you buy a vehicle and use it in your business, if the purchase price of that vehicle is over a certain limit ($15,800 in 2014), the tax law limits how much you can deduct each year. So, if you buy a $40,000 vehicle, you may have to depreciate the vehicle for a very, very long time—not optimal.
When you lease a vehicle, to the extent that you use the vehicle for business purposes, you can be deducting your vehicle payments. Example: I pay $300/month for a leased Honda and I used it for business 90% of the time. I can deduct $3,240 ($300 x 12 months x 90% usage).
There is a very small amount called the “Lease Inclusion” that cannot be deducted, but it is too small to be concerned with. This “Lease Loophole” is the reason why most luxury vehicles on the road are leased.
Related: Options For Getting Out Of A Car Lease
Q – How much depreciation can you take if you purchase your car?
This deduction lets you write off your investment in a business vehicle. This is also called “basis.” Multiply the basis amount by the percentage of business use of the vehicle to determine how much you can depreciate each year. If you use a car 100 percent for business, you may depreciate its entire basis. If you use it 50 percent for business, you may depreciate only half of its basis.
How do you determine your car’s basis? It depends on how you got it and when you began to use it for your business.
If you buy a business vehicle and use it that same year, your basis is its cost. If you trade in your old vehicle to a dealer to buy a new one, your basis is equal to the adjusted basis of the trade-in. This includes the original cost minus depreciation taken, plus the cash you pay. The cash includes the out-of-pocket costs or if you financed with a loan.
If you convert a vehicle that you previously owned for personal use to a business vehicle, your basis is the lower of what you paid for it or its fair market value at the time you convert it to business use. Your basis will usually be its fair market value, as this is usually the lower number. You can determine the fair market value by checking used car value guides, such as the Kelley Blue Book.
Related: Is Owning Two Cars Worth It?
Depreciate Limit For Cars For Vehicle Expense
| Tax Year | Standard | 50% Bonus |
|---|---|---|
| First Year | $3,160 | $11,160 |
| Second | $5,100 | $5,100 |
| Third | $3,050 | $3,050 |
| Subsequent | $1,875 | $1,875 |
Depreciation of Trucks And Vans
| Tax Year | Standard | 50% Bonus |
|---|---|---|
| First | $3,560 | $11,560 |
| Second | $5,700 | $5,700 |
| Third | $3,350 | $3,350 |
| Subsequent | $2,075 | $2,075 |
There are two basic methods to depreciate a vehicle: the straight-line method which gives you equal deductions each year except for the first and last year; and accelerated depreciation, which gives you larger deductions the first few years you own your car. You must use your vehicle for business more than 50 percent of the time to use accelerated depreciation.
However, no matter which method you use, your deduction will be subject to the annual limits set forth above. Thus, depending on the value of your vehicle, it may not make much difference which method you use.
Q – Can I deduct my spouse’s vehicle?
A – It depends. If your spouse uses their vehicle for business purposes, then the business can reimburse that mileage and get the deduction. However, businesses cannot deduct vehicle expenses if the vehicle isn’t actually used in or for the business. In short, your business won’t get a deduction for your trips to the grocery store.
Vehicle Expense Deduction Is Great When You Have A Business
If you ever start your own business, you can consider getting a 6,000+ SUV or truck and deduct the entire expense if you want.
There are also plenty of other expenses you can deduct to an income statement if you own a business. See a sample income statement below:
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