Should you buy a new vehicle before year-end to get a tax deduction?
It’s a great question and I get this asked a lot. After all, it makes sense, right? Big ticket item should mean big tax savings?
It very well could!
First, I always ask a few questions:
- Do you need a new business car, truck or SUV in the next 6-9 months? If not, the tax savings won’t be enough to make economic sense in your business. Remember, the tax savings are only a fraction of the cost of a car. For example, if you buy a car for $36,000 and are in a 30% combined federal/state tax bracket, you’ll only save $10,800 in taxes. You’ll still be out-of-pocket by $25,200. If you don’t need it, the tax savings alone can never justify the purchase.
- Do you use it predominantly (more than 50%) for business?
If the answer to both of those questions is “yes”, then buying a vehicle before year-end may make sense. When that’s the case, we usually get into another question. Should I buy a vehicle that qualifies for the special Section 179 deduction? The section 179 deduction is a special acceleration of the normal depreciation rules, and allows you to write off a much larger portion of the vehicle in the year you purchase it. Remember though, it accelerates the deduction, it doesn’t provide a higher overall deduction. It just lets you write it off sooner. That’s usually a good thing though, especially if you’re in a higher tax bracket this year than you will be in future years. But if you’re going to be in a higher tax bracket next year, you may just want to hold off on that purchase until next year where the deductions provide you more value.
Assuming it makes sense to get that tax break this year, here are some things to know about vehicle purchases.
- If you are operating your business as a corporation or partnership, then the vehicle must be titled in the corporation or partnership name. Otherwise, the special bonus depreciation and Section 179 rules do not apply to you. If you are operating as a sole proprietor (including a single-member LLC who has not chosen to be taxed as an S-corporation) you can still title the vehicle in your name. However, if asset protection is the reason for choosing an LLC, talk to your lawyer about whether this can damage the legal protection of the LLC.
- The IRS classifies vehicles into several categories. Generally speaking, these categories are 1) passenger vehicles that weigh under 6,000 pounds, 2) SUVs that weigh over 6,000 pounds, and 3) trucks. There are variations and exceptions, so let us know if you need more clarification.
- The first-year depreciation limits depend on these classifications, as well as whether the vehicle is new or used. Passenger vehicles could be limited to total depreciation of $11,160, if it is new ($3,160 if it is used) and you use the vehicle 100% for business. Limits are much higher for vehicles over 6,000 pounds.
- The way you determine the business usage is by mileage. Business miles divided by total miles equals your business usage percentage. Business mileage does not include commuting. For example, if you are a doctor and travel only between your home and office, plus other personal errands, you do not have business usage. However if you are in sales working out of your home office, it is very likely you will have a very high business usage percent.
- Section 179 is available on all vehicles, but practically speaking it is a non-issue for passenger vehicles due to overall depreciation limits. For SUVs over 6,000 pounds, you can take $25,000 in section 179 deduction, 50% bonus depreciation on the remaining cost, and yet more regular depreciation after that.
- In order to qualify for Section 179 deduction, your business use must be over 50%. If business use is less than 50% you don’t qualify for the Section 179 deduction and the depreciation method used to write-off the vehicle is a less favorable method.
- The Section 179 deduction for trucks are limited only by the $500,000 overall limit for section 179 deduction for the business. Therefore, many businesses can write off the entire purchase of a truck if there are not significant purchases of other equipment also qualifying for the Section 179 deduction.
- The first-year combination of section 179 deduction or bonus depreciation can be limited by your business use in the first year. For example, if you purchase an SUV and use it only 52% of the time for business purposes, you will not receive the full $25,000 SUV write-off you normally hear about. However if you buy an SUV type vehicle now and use it 100% for business for the rest of the year, you could have a very nice tax break for this year.
- If your business use drops to below 50% in any of the next 5 years, and you took the Section 179 deduction when you purchased it, you will need to recapture some of that first-year deduction. Recapture involves recalculating the depreciation and recording income for the excess Section 179 deduction you took in that first year.
- Don’t forget the value of having your business reimburse you for mileage at the standard mileage rates, instead of buying the vehicle in the name of the business. If you drive your car mostly for business and have a significant amount of business miles (over 14,000 miles), you may be better off buying the car in your own name and having your business reimburse you. For 2016 the rate is $0.54/mile. If you drove 15,000 miles and own a passenger vehicle, that’s a write-off of $8,100 every year. If you use your car for personal reasons also, the mileage method of writing off your car could be significantly higher than if the business own the vehicle.
- If the business owns the vehicle in a corporation or partnership, and it is used for personal use in addition to business use, the IRS requires that you either reimburse the business for personal use, or a value for that personal use is added to your W-2 in the form of compensation. For example, for a vehicle that cost $35,000 and incurred $2,000 in gas expense, you would have to add $4,500 to your W-2 as taxable compensation. And your business must also pay FICA and Medicare taxes on that additional compensation.
The tax rules surrounding tax vehicles are complex. Please let us know if you have specific questions.