Auto Deductions, What Options Do I Have?
- Nov 27, 2024
- 12 min read
Updated: Dec 30, 2024
If you own a vehicle, you should be deducting it. This guide will walk you through how to write-off your vehicle expenses based on how you use the vehicle, what type of vehicle you own, and how many vehicles you own. Lets dive in.
I Lease a Vehicle, Can I deduct it?
The short answer is yes, but the rules are slightly different. For cars you own, principal payments on your auto loan cannot be deducted. But for cars you lease, the full lease payment can be deducted. If you do not drive much (<10k miles per year) and would like to try a variety of vehicles with a lower monthly payment, leasing might be your best option. Keep in mind, if you decide to use the standard mileage method for a leased vehicle, you have to use it for the entire duration of the lease period. If you decide on the actual method, you must use this method for the entire duration of the lease period. Because of these rules, I typically recommend that clients use the actual method for leased vehicles. Make sure to ALWAYS ask your accountant about which method is best for your unique tax situation.
Owner Tip: It is a trick of the trade to treat capital leases as the purchase of a vehicle if the buyout option is $1.00. This strategy has been successfully defended against the IRS, thus is a legitimate tax strategy that you should keep in mind when deducting your vehicle expenses. Do not attempt this strategy on your own, ALWAYS ask your accountant.
I Bought a Vehicle, Now What?
Congratulations! Your business is booming and you can finally afford to ditch that 1997 Toyota Camry with 200k miles on it and a broken front bumper. The date of purchase will be the date the vehicle is "placed into service". An important consideration to make is whether you can operate the vehicle. If you bought the vehicle on April 8th 2023, but it took 3 days of repairs to make the vehicle operational, then the date placed into service for your business would be April 11th 2023. Depending on when you bought the vehicle, you may want to take either standard mileage or use the actual method. If you bought the vehicle in December, you might want to consider the actual method. This is because you will only have one month of miles to write off for this vehicle. If you bought in January, you may want to consider the standard mileage method. As always, make sure to ask your accountant which strategy is best for you.
Fun Fact: When I was in college, I bought a 1997 Toyota Camry for 1,500.00 that had the front bumper taped onto the vehicle. It only lasted 1.5 years and countless repairs before my mechanic noticed that the engine was melting. I ended up selling the vehicle to a scrapyard for 100.00 dollars, keep reading to see whether scrapping your vehicle is a good decision for your business.
Does my business have to own the vehicle?
From a tax standpoint, your business does not have to own the vehicle to take the standard mileage deduction or use the actual method. However, contributing your vehicle to your business can help you avoid negative basis issues, so make sure to ask your accountant if this strategy is right for you (Read basis article for more information). If you have asset protection concerns, ask your attorney about contributing your vehicle to your business.
Business Miles Vs. Personal Miles
As a general rule of thumb, personal miles include any commuting and personal errands. Commuting means traveling from your home to your "main or regular place of work". What if you take a business call while commuting, does that change the miles from personal to business? No, please stop trying to create loopholes and leave tax deductions to the professionals. What if I leave my home, take a client to lunch, then drive to the office? If that is the case, then all miles will be considered business miles for those two trips (home to client lunch and client lunch to office). Personal errands means... just kidding, that's your business and I don't care (it means exactly what it sounds like, grocery shopping, going to the mall, etc.).
Business Miles include any mileage driven for business purposes outside of your regular commuting. Make sure your miles are deductible by making a business trip before heading to the office, here are some common mileage strategies that work:
If you have a PO Box for your business, stop by there and check the mail before heading to the office.
If you need to pick up some supplies before you go to the office, this stop will make the full trip deductible.
If you want to surprise your staff with doughnuts for some Friday shenanigans, stopping at the doughnut shop to pick these up will make your full trip deductible.
Owner Tip: If your home is considered your "principal place of business", you can deduct business miles for any trip from your home to a work location. The principal place of business is where you spend the MAJORITY of your time working on your business. That being said, if you also have an office location then you can still declare your home your "principal place of business". As the saying goes, ALWAYS ask a professional regarding your unique tax situation.
Which Strategy is Best for Me?
As an accountant myself, the answer is always "it depends". To provide some clarity on tax strategy, I have outlined a few points your accountant should consider when making this tax decision:
How many business miles do you drive? If you drive a lot (more than 10k miles per year), you might want to consider taking the standard mileage rate. If you drive very little (less than 10k miles per year), the actual method may be best for you. If you drive your vehicle <50 percent for business, then you HAVE to use the standard mileage method. Note that if the business use for a vehicle drops below 50 percent in a subsequent year, you are required to use the standard mileage method and recapture any depreciation previously taken using the actual method.
What was the purchase price of the vehicle? Automobiles have a 5 year class life, which means their full value can be depreciated over 5 years (depending on your situation, you may be able to depreciate the full value of the vehicle in a single year). If the purchase price was high (>35k), you might want to consider using the actual method. If the purchase price was low (<35k), you may want to take standard mileage. If the purchase price of your vehicle is extremely low (<25k) and gets good gas mileage, you may even be able to turn your vehicle into an asset that generates cash through standard mileage deduction tax savings!
Do you plan on selling the vehicle later? With the Covid-Era greatly inflating the used car market, it may be wise to sell the vehicle later on. Depending on the vehicle, you may even get more for it used than what you paid to purchase the vehicle! While this is uncommon, I have seen this happen firsthand. However, selling a vehicle may have tax consequences beyond paying capital gains if you sold for a profit. When selling a vehicle that was depreciated, you will have to recapture those depreciation expenses in the form of ordinary income taxed at your marginal tax bracket.
What is the GVW of the Vehicle? If you purchased a vehicle with a gross vehicle weight (GVW) of <6000 Ibs, you may be subject to luxury depreciation limits which will be in place for the first four years of vehicle ownership. These depreciation limits impact the amount of Section 179 and bonus depreciation you may take. The first year limit for luxury vehicles is 20,400.00 for 2024 if you claim bonus depreciation, and only 12,400.00 without bonus. Subsequent years allow even less depreciation, with the 4th year limit only being 7,160.00! To avoid this, please see the 4th resource provided which has a table of luxury vehicles not subject to luxury limits based on GVWs that are all >6000 Ibs.
What Method Have I Used in the Past? If you have already used the actual method and are considering switching to standard mileage, I have some bad news for you. You cannot do this. The method you use largely depends on the method used the year the vehicle was placed into service. If you used the standard mileage method for year 1, you may switch to the actual method for year 2. Keep in mind that if you want to switch to the actual method then you need to use the vehicle for business at least 50 percent of the time.
How Will My Taxable Income Change Over Time? When starting out in business, you typically experience significant growth year-over-year. Because of this, you might want to save deductions for future tax years where your taxable income may be higher. You can always choose to take mileage your first year and switch over to the actual method in later years when it makes more sense to do so. Ask your accountant about this.
Audit Avoidance Tip: If you only have one vehicle available to you then you will want to double and triple check that your business use was greater than 50 percent if you use the actual method. Second, if you have a W-2 job and are just starting out as a side hustle then you may want to consider getting an app like Mile IQ to track your business and personal miles. Remember, commuting and personal errands do not count towards business miles. "Pigs get fed, hogs get slaughtered": Do not get overly aggressive with this deduction if you are reporting business income/losses on a Schedule C (if your business is a sole proprietorship)! Lastly, ALWAYS ask your accountant which method is best for your unique tax situation.
Asset Sale Tip: If you do decide to sell your fully/partially depreciated vehicle, make sure to record all the expenses associated with selling it. This will help offset any depreciation recapture that occurs. Secondly, the more depreciation taken, the larger the depreciation recapture tax. Try and avoid selling fully depreciated vehicles to avoid any surprises come April 15th. However, you can avoid depreciation recapture by scrapping/disposing of your vehicle. Lastly, ALWAYS ask your accountant before creating a taxable event.
Owner Tip: If your accountant gives you standardized answers to your tax planning questions, it might be time to shop around for a new accountant. Accountants should be using their knowledge of your tax situation to help you save as much on taxes as legally possible. Examples of some variables include how many miles you drive, the price of your vehicle, and whether you plan on selling the vehicle down the road.
Standard Mileage Deduction
This is the most common deduction as it is fairly straightforward. Every year, the IRS provides guidance on the standard mileage rate for the tax year. For 2023, the standard mileage rate was 65.5 cents per mile. Every year, this figure is adjusted for inflation. For example, the 2024 mileage rate was increased to 67 cents per mile. Every so often, the IRS likes to switch things up, such as in 2022 where they had two separate standard mileage rates for miles drove between Jan-June and June-December. These rates were 58.5 cents and 62.5 cents respectively. By looking at these trends, we can see that the standard mileage rate increased by almost 10 cents per mile from 2022-2024, which makes this deduction particularly attractive. However, if you own a fleet of 5 or more vehicles, then you are required to use the actual method. As with everything in the tax world, there are some caveats. Lets provide an example of the mileage calculation and define the terms "business miles" and "personal miles".
Owner Tip: Tired of worrying about depreciation recapture? Worry no more! The IRS has came out and said that there is no depreciation recapture for vehicles that only took the standard mileage deduction. If you plan on selling your vehicle, it might be wise to take the standard mileage deduction to avoid increasing your tax liability in the future. Lastly, everyone's tax situation is unique, ALWAYS make sure to ask your accountant before you create a taxable event (See Depreciation Recapture article for more information).
Owner Tip #2: If you have a spouse (filing married filing jointly) and they drive their vehicle for your business, you can write off their miles too! This is because of the family attribution rules which state that if you are a shareholder of a business, your spouse is too. Don't get it twisted, if your spouse gets a 1099 or earns their own income without relying on an employer, they likely have a business (See Am I Running A Business Or A Hobby?). If this is the case, they can write off their own mileage too! Either way, you get to deduct both your business miles.
Mileage Calculation
Lets say that Bob owns a 2023 Nissan Versa. He bought the vehicle on 04/01/2023 with 36 miles on it. On the morning of January 1st, 2024, he walks out to his vehicle and snaps a picture of the odometer. The odometer reads "10,236" miles. Because he is a responsible small business owner, he used MileIQ to track his business and personal miles for the year. Based on the MileIQ 2023 mileage summary, he drove 2,654 miles for personal use and 7,546 miles for business. Based on the information provided, Bob would be able to deduct $4,942.63 in expenses for his vehicle. This number was calculated by multiplying 7,546 by .655 (65.5 cents per mile in 2023). If Bob has an average tax rate of 22 percent, this results in $1,087.38 of tax savings!
Owner Tips: If you forgot how many miles the vehicle had when you purchased it, there should be an odometer reading of the current mileage on the purchase paperwork. If you forgot to track your mileage for the year, you can track your mileage for two weeks and extrapolate the data. Third, avoid being lazy and using round numbers to guesstimate your mileage (I have seen this practice be audited by the IRS, make sure to provide accurate data to your accountant). Lastly, make sure to ALWAYS let your accountant know when you purchase a vehicle and provide the accompanying paperwork.
Actual Method Calculation
With the standard mileage method, Bob calculated that he can save 1,087.38 on his tax bill. Lets see how much he can save through use of the actual method. First, we need to determine whether he qualifies for this method. As you recall from the previous example, Bob drove a total of 10,236 miles with 7,546 miles for business and 2,654 for personal use. To calculate the business use of the vehicle, divide the business miles by total miles driven. In this example, the business use percentage of Bob's 2023 Nissan Versa is 73.7 percent. Since this number is greater than 50 percent, he meets the criteria! To use the actual method, we need more details on the purchase and auto expenses for 2023.
Bob purchased the vehicle for 25,000.00 on 04/01/2023
2023 Vehicle Expenses:
Gas - 1000.00
Repairs & Maintenance - 500.00
Auto Insurance - 850.00
Depreciation Expense - 5000.00 (5 year class life taking no bonus/sec. 179)
Using the actual method, Bob would be able to claim a deduction of 7,350.00. With an average tax rate of 22 percent, this would save Bob 1,617.00 dollars on his tax bill!
Owner Tip: Expenses for parking & tolls are not included in the actual method calculation and are deducted separately regardless of whether you use actual or mileage. That is, fees related to parking & tolls are "ordinary" and "necessary" expenses for any business. That being said, do not use this expense account to make decisions regarding the actual method vs standard mileage!
Based on the Calculations Provided, Which Method is Best for Bob?
My answer would still be "it depends". I would need a more comprehensive look at his financials to make an informed decision. For example, what is his projected growth? If he ends 2024 with 50,000.00 more in taxable income, it may be wise to use the standard mileage method in 2023 and then switch to the actual method in 2024. For this strategy to work, Bob would need to maintain a business use greater than 50 percent for 2024. How many deductions/credits can he claim on his 1040? I have seen business owners report >100k in net income for their business and pay less than 1k in taxes because of all their personal deductions/credits. On paper, it may look like the actual method yields a better result. However, it may not be the best strategy for tax planning purposes. It may yeild a better result in 2023, but what about 2024? By taking the actual method, you can no longer claim mileage in subsequent years. What if your 2024 mileage is double your 2023 mileage? What if you sell the vehicle in 2024? These are examples of just a few variables your accountant should be considering. Remember, when running a business, play the infinite game. What I mean by this is that the player that stays in the game the longest typically wins, which is due to the compounding effect of time on money. Playing the finite game will only get you so far, and may cause you to go out of business. This is because the finite game involves reactive decisions instead of proactive decisions.
Owner Tip: When choosing an accountant, consider their scope of work. At minimum, your accountant should be doing your bookkeeping, business tax preparation, and personal tax preparation. Do not deviate from this criteria, it is impossible for an accountant to estimate your tax liability without being involved in these 3 processes. If you have more than 1 million in gross revenue, consider expanding that scope to include additional services such as sales tax filings, payroll services, and CFO services.
How Do I Substantiate My Auto Deduction?
If you used the standard mileage method, take a picture of the odometer at the beginning of the year and end of the year. Then use an app like Mile IQ to track business and personal miles. Mile IQ has a year end summary which makes it extremely easy to take the standard mileage deduction, and the strategy is audit proof with this substantiation!
If you use the actual method, you will need to save your receipts for at least 3 years (the IRS actually recommends saving them for 5 years). Please see the following IRS list for all auto expenses used to calculate the actual method:
Gas
Oil
Repairs
Tires
Insurance
Registration Fees
Licenses
Depreciation
Sources:
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