Deducting Your Automobile Expense on Your Business: Know the Rules
As a business owner or entrepreneur, managing your expenses wisely can significantly affect your bottom line and your tax bill. One area where you can realize substantial tax savings is through the strategic deduction of your car's operating and ownership costs. However, navigating tax law can be complex, so let's break down what you need to know.
What's Allowed?
If you have a vehicle that is used exclusively for business and have a second vehicle that you use personally, you're in a favorable position. The IRS permits you to deduct the total cost associated with owning and operating your vehicle. You can use either of the methods listed below, but it is not necessary to allocate any of the cost to personal use.
When it comes to calculating your automobile expenses, there are two primary methods: The Standard Mileage Rate or Actual Cost.
To use the standard mileage rate, you must use this method in the car's first year of business use. Once you choose this method, it is possible to switch to the actual expense method in subsequent years, but you should consult your tax advisor for information on how to make the switch for your specific situation.
Standard Mileage Rate: This method is relatively straightforward. You calculate your deduction by multiplying your business miles by the standard mileage rate of the year. For 2024, the rate is set at $0.67 per mile. This rate can change within the year, so you should reference the IRS “Standard Mileage Rates” chart. This chart gives a breakdown of the mileage rate(s) for each tax year. Keep in mind that not all your work-related miles are deductible. For instance, your commute from your home to your regular job location is considered a personal commute and is not a deductible expense (see corresponding figure). Trips to the bank, post office, visits to clients, the store for supplies, and other locations for your business are examples of deductible business miles. It is crucial to keep a log of these trips which should include the date, the business purpose and destination and the business miles for the trip. There are several helpful apps available that can ease the burden of keeping this information which also give you the ability to provide a report to your CPA at tax time. IRS Publication 463 has more details and examples relating to “Travel, Gift, and Car Expenses” if you are looking for more information on this subject. One thing to note, if you plan to use the Standard Mileage Rate and you have taken depreciation on your vehicle in the past, it's wise to check with a tax advisor before claiming the standard mileage rate on your tax return.
Actual Expense Method: To go this route, you'll need to calculate the real costs of operating your car for business. This includes gas, oil, repairs, tires, insurance, registration fees, licenses, and either depreciation or lease payments, apportioned to the percentage of total miles that are business miles. If your business purchases and keeps the vehicle on its balance sheet and has a loan for the vehicle, you can also deduct the interest on the loan. If you purchase the vehicle personally this interest is not deductible. To use your vehicle for both personal and business purposes, you will also need to log the business miles and purpose for each trip and record the total miles driven for the year. The total business miles divided by the total miles will give you a ratio. This ratio is multiplied by your expense so only the business portion is deducted. To keep the total miles, you simply need to record the miles from your odometer at the beginning and end of each year.
If you choose the actual expense method, remember that you will need to calculate depreciation in addition to the other costs associated with operating your vehicle. The deduction for depreciation can be quite beneficial in the year you acquire the car and is a great tax planning opportunity.
Special Considerations for First Year Depreciation:
Passenger Vehicle Caps: Congress has set limits to the deductions available for passenger automobiles. In 2024, the maximum first-year depreciation deduction for most passenger automobiles is $12,400, plus bonus depreciation of an additional $8,000 for total maximum first year depreciation deduction of $20,400. Sport utility vehicles, trucks, or vans that have a GVWR (gross vehicle weight rating) of less than 6,000 pounds are considered passenger vehicles.
Sport utility vehicles, trucks, or vans with a gross vehicle weight rating greater than 6,000 pounds are not subject to the same passenger vehicle caps and limits on bonus depreciation. In 2024, the deduction for bonus depreciation on these vehicles is 60% of the purchase price with the remaining 40% being depreciated using MACRS (modified accelerated cost recovery system) or straight-line depreciation. This will get you very close to deducting the entire cost of the vehicle in the first year. To qualify for bonus depreciation, the vehicle must be used more than 50% for business use.
In addition, you can deduct depreciation and bonus deduction even if your vehicle is financed, giving you an upfront tax deduction even before you have had to spend the cash on the automobile. If you have leased your vehicle, you are not allowed depreciation, but the business portion of your lease payment is deductible.
Remember, for those who use their business vehicle for personal drives, including commuting, you must allocate the deduction to exclude personal use. For example, if you use your vehicle 60% of the time for business and 40% personal use, you would use 60% of the purchase price as the starting point for your depreciation calculation. As long as your vehicle is used more than 50% for business throughout the year, you can prorate your deduction to reflect this usage.
The Bottom Line
If your business activities rack up substantial mileage, the standard mileage rate often provides a more advantageous deduction. However, the actual expense method could yield higher savings if your car-related expenses are significant and well-documented. The best method can be estimated by multiplying the amount of business miles you estimate you will drive in a year by the mileage rate and comparing that amount to your estimated total vehicle expense for the year. Your tax preparer can perform this calculation with actual amounts prior to filing your first return claiming the deduction for the vehicle.
In all cases, record-keeping is your best ally in leveraging these deductions to your advantage. When in doubt, or when facing complex tax planning decisions, seeking advice from a professional tax advisor is your best course of action.