Understanding Auto Deductions

by John Larson

A question we get asked over and over is “I need a new car – should I have my business buy it?” This is a great question and we will try to share some useful information to think about.

Deducting automobile expenses in a business can be a bit complicated. There are two ways to do it: you can either deduct actual expenses or you can deduct mileage expense (54 cents a mile in 2016). Actual expenses include depreciation expense, which we will discuss in a moment, gas, oil, repairs, tires, insurance etc. If you choose to use the actual expense method in the first year, you must continue to use that method until the car is no longer in service. You may not switch methods year by year just because one may be a better deduction than the other in that particular year. In either case it is important to keep track of your mileage using a log of some kind, and if actual expenses are used, be sure to keep all receipts for gas etc.

When a business owns a vehicle it will be 100% deductible by the business. If there is any personal use of the business-owned vehicle (small business owners often use the company car for personal reasons), the personal use amount must be included in the owner’s income. If the owner is also an employee, then the personal use amount will be included in the W-2 box 1 wages of his or her W-2. The personal use is considered a fringe benefit that must be included in the beneficiary’s income. The business use versus personal use is the reason a mileage log should be kept even if you aren’t using the standard mileage method.

We said that auto deductions were a bit complicated – well, if the above wasn’t enough for you, now let’s talk about depreciation. An additional question we get asked in relation to the car is, “if I buy a car can I depreciate the whole vehicle this year using Section 179?” And the answer is maybe.

First, let’s get some terminology out of the way. Without getting into too many specifics – most assets have the option of being depreciated using Section 179 (eligible to expense the entire cost in the year of purchase) or also using ‘bonus’ depreciation (eligible to take half the cost of a new asset in the year of purchase plus depreciation on the remaining value). These methods are meant to incentivize business owners to spend money on assets and accelerate tax savings at the same time.

There are 3 tiers to vehicle depreciation using accelerated methods.

The first is cars that are considered listed property. Listed property includes passenger automobiles rated at 6,000 pounds or less of Gross Vehicle Weight (GVW.) This is going to encompass most cars and small SUV’s. If a vehicle is considered listed property, the depreciation is severely limited in all the years it is depreciated. An automobile has a 5 year life according to the IRS. So for a non-vehicle asset that cost $30,000 we would normally be able to use an accelerated depreciation method and take approximately $6,000 of depreciation the first year.

The important thing to note is that listed property isn’t eligible for Section 179 and is limited in how much bonus and regular depreciation can be taken. The regular depreciation is limited to $3,160 and the bonus is limited to $8,000 for a total first year deduction of $11,160. The 2nd year is limited to $5,100, the 3rd year is $3,050 and it’s $1,875 for each successive year. These amounts need to be reduced for personal use as well. So if personal use was 25% then first year depreciation would be limited to $8,370.

The second tier is an SUV that weighs over 6,000 pounds GVW. If you buy an SUV that qualifies you can take up to $25,000 of section 179 in the first year plus regular depreciation (without the limits discussed above).

The third tier is trucks and vans over 6,000 pounds GVW. This tier finally surpasses any limitations mentioned above and can expense the entire amount in one year using Section 179 (if it otherwise qualifies under the Section 179 rules).

In addition to everything discussed here, it is wise to also speak with your attorney about how to protect you and your business from the liability created when the business purchased the vehicle. As you can see, auto deductions are complicated and we have only scratched the surface. Each situation will be different and unique. As always, it is best to talk to your advisers before you make decisions because they can often help educate and inform you so you can make the best decision.