Buying a vehicle for business use can come with sizable tax benefits—if you meet the
qualifications. Tax law treats vehicles differently than other business assets and expenses, so business owners need to understand current regulations to ensure they qualify for deductions. Below we will explore the possible tax benefits and limitations when you buy or lease a vehicle for business purposes.
THE TAX CUTS AND JOBS ACT: TAX BREAKS FOR BUSINESS VEHICLES
The Tax Cuts and Jobs Act (TCJA) of 2017 made a number of amendments to the federal tax code. Among its many changes, the Act allows businesses that purchase any qualifying business assets, including vehicles, to take a depreciation deduction in the first year after the purchase. This benefit is also known as bonus depreciation. Taxpayers can deduct 100% of the cost of the vehicle as long as the vehicle is new or new to the taxpayer and is acquired and put to use between September 28, 2017 and December 31, 2022.
The TCJA also permanently increased the limits for business expenses under Section 179 of the tax code. Starting in tax year 2018, the maximum deduction was set to $1 million, and the value of property purchased is set to $2.5 million. This threshold is adjusted annually for inflation, so the exact limit will vary (check the official IRS website for the 2020 and 2021 tax year limits).
PASSENGER VS. HEAVY VEHICLES
If the 100% bonus depreciation sounds too good to be true, you should note that several important restrictions do apply. The first has to do with the type of vehicle your business uses. Heavy SUVs, pickups, and vans are considered transportation equipment from a tax perspective and are the primary target for this tax break. The taxpayer can deduct the full price of the vehicle in the year of purchase.
THE 50 PERCENT RULE
The next restriction to keep in mind is that a taxpayer can only deduct the business-use portion of the vehicle. On top of that, the vehicle must be used for business purposes more than 50% of the time to qualify for bonus depreciation and Section 179 benefits. If your business use is 50% or less, you are only permitted to use the alternative depreciation system (ADS) on the vehicle, which calculates the year-by-year depreciation more minutely and typically results in smaller deductions over a longer span of time.
USING THE STANDARD MILEAGE RATE
If you are an individual business owner (not paying taxes as a partnership or corporation), instead of dealing with depreciation deductions and their limitations, you can instead calculate and claim your vehicle expense using the standard mileage rate. In 2021, this amounts to 56 cents per mile.
One caveat here is that you need to decide in Year 1 whether you want to use the standard mileage rate or claim depreciation plus operating expenses (gas, oil changes, etc). Once you make that claim, you’re locked into that methodology for future years for the same vehicle. If you do decide to switch from standard mileage to actual expenses in a future year, your methods for calculating depreciation will be restricted
LEASING BUSINESS VEHICLES
How do these tax rules apply if you are leasing the vehicle instead of buying it? Taxpayers are still allowed to deduct the yearly lease payment as an expense. Similar to the rules for buyers, this amount must be adjusted to reflect the percent of time the vehicle is used for business.
In lieu of the limitations set for depreciation deductions, lease holders must do a lease addback based on the market value of the vehicle. This rule essentially exists to create more equality between purchases and leases in terms of tax benefits. The IRS releases guidelines annually that list the amount taxpayers need to account for (see Revenue Procedure 2020-37 for the most recent chart).
SUMMARY: DECIDING TO BUY OR RENT
If your business is weighing the pros and cons of buying or leasing a vehicle, be sure to factor in the tax impact by considering:
● The type of vehicle (passenger or heavy)
● The percentage of time that vehicle will be used for business
● The potential lease addback
● The most recent IRS depreciation and lease inclusion charts (Revenue Procedure
2020-37)
In addition to the factors above, you also want to consider the immediate expenses. While buying a heavy vehicle might offer the most straightforward tax deduction, this option could set you back $60,000 for the cost of the vehicle alone. On the other hand, leasing may allow you more flexibility to match your payments to your cash flow, but you will encounter some limits to your tax benefits in addition to not owning the asset outright.
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