[Editor's Note: This is a guest post from a physician and regular reader named Alex, who wanted to share some of his insights regarding the deduction of vehicle expenses. At any rate, it's a good post and we don't have any financial relationship.]
Have you ever wondered what is the most tax-efficient way to deduct your vehicle for business purposes? Is it more profitable to deduct mileage or actual expenses?
The Mileage Method Tax Deduction
When using the mileage deduction method, for every mile you drive in 2014 the IRS allows you to deduct $0.56. Therefore, if you drive 10,000 business miles you can deduct $5,600. This method becomes advantageous when your vehicle is a $5000 beater. However, what if you have lived below your means and done well for yourself, and now desire a more expensive vehicle?
The Actual Expense Method Tax Deduction
A better alternative to the mileage deduction method may be to make deductions based on your actual expenses. Actual expenses are considered to be what you spend on your car (i.e. gas, repairs, registration and insurance), and when you sell the car you can deduct capital gains loss (purchase price minus selling price.)
Below is an example of actual expenses for my recently purchased Audi S5. I will then compare it to the basic mileage deduction.
For this calculation let’s assume that the car is driven 10,000 miles per year for 5 years, and then sold.
- Audi S5 price: $63K in cash
- According to Kelly Blue Book, a 5 year older S5 with 50K miles is worth ~$33K. Therefore, there will be a total of 30K depreciation on the vehicle when sold in 5 years
- If driven 50K miles with gas costing $3.8/gallon and a gas mileage of 22 mpg, I end up spending $8,363 on gas.
- Insurance is approximately $1,000 per year and for 5 years will total another $5,000
- For repairs or maintenance, edmunds.com estimates approximately $3,000
- Registration and inspection adds another $250 over the 5 years.
– The total cost to run this car is $16,613. If I then sell the car to a private party at the Kelley Blue Book value I have an asset depreciation of $30K for a total expense of $46,613. All of this can be deducted from my taxes over the course of those 5 years with the largest deduction when I sell the vehicle.
If I only deducted mileage, 50K miles at $0.56 per mile comes to $28,000 over the course of 5 years. [To be fair, that deduction will probably go up a few cents a year, but it won't change the conclusion-ed]
– This reveals approximately an $18K difference and when paired with the 33% federal tax bracket is an extra $6K I get to keep away from Uncle Sam by using actual expenses.
What About Vehicle Tax Deductions For Personal Use?
Now, let’s say you use the exact same example but use the vehicle only 50% of the time for business… this will cause a 50% difference as you are only allowed to deduct half the amount for the 50% of the time you are using it for business. Also, if you sell your car for less than KBB to, lets say a lucky relative, these figures further improve in your favor. [Of course, the IRS may look at the difference between a fair price and your price and rule that the difference is a gift to the relative, but there is probably some room there for reasonable disagreement about the car's value.-ed]
Now, you might say, “The IRS has specific rules for depreciation and states that you can only depreciate by the amounts they have specified.” Well, for 2013 the IRS allows the following yearly depreciation on your vehicle:
- 1st Tax Year $11,160
- 2nd Tax Year $ 5,100
- 3rd Tax Year $ 3,050
- Each Succeeding Year $ 1,875
Therefore, in 5 years I get to depreciate $23,060. What their specified depreciation does is decrease my cost basis for the car. As long as the car is sold to a private party, the total depreciation is adjusted by the new cost basis. In this example, my $63K car with 5 years IRS stated depreciation is now worth $39,940 and if sold for $33,000, I qualify for a capital gains loss of $6,940. This can be deducted as well.
Let’s say you’re involved in a major car accident rendering your car nearly worthless. The IRS will share your burden as the car will be sold far below $33K, therefore increasing your deduction. [Although, if you were deducting the cost of comprehensive/collision insurance, I don't think the IRS is then going to allow you to depreciate the loss of value that you were insured against. But if you just had liability insurance, that seems reasonable to deduct your loss. I'm sure some of the CPAs reading this will correct me if I'm wrong-ed]
An additional advantage occurs when you have more than 1 vehicle. If you need to utilize the other car for your business driving needs, then you can deduct $0.56/mile on that vehicle, thereby increasing your deductions further.
The last advantage is that the IRS will also shares the cost of modifying the car. If, for example, I opted to install a new exhaust or a bigger supercharger, well, that is counted as a car expense and is also deductible. [Gray area here- perhaps should be taken as an addition to basis-ed]
Note that I do not condone buying vehicles outside of your means. It is not appropriate to spend an extra $1 just to save 33 cents in taxes. Just to be clear, I am a strict follower of WCI advice. If you can’t pay cash then you shouldn’t be driving a luxury car or a sports car, even if you get a deduction for it.
[Editor's Note: Expenses related to a leased car used for business purposes are also deductible, of course. That doesn't mean leasing is better than buying (it usually isn't) but you'd have to run the numbers for yourself to come to that determination. I've run into several doctors whose practice subsidized a vehicle purchase to the point where, especially after-tax, leasing was actually a pretty good idea for them. This is also a good place to remind readers that your commute and expenses associated with it are not deductible. If you work at two sites, the only deductible mileage is the mileage between the two sites, not the mileage between home and site A, or the mileage between site B and home.
The bottom line of this post is that if you have a new, expensive vehicle, it's worthwhile to keep all your receipts and deduct your actual expenses, but if you have a 14 year old Durango like me, you're better off with the mileage. Either way, keep good records in case of audit.]
Does anyone else use actual expenses on their business vehicle? Does anyone have a more tax efficient way to deduct their car? Please share your thoughts.