A taxpaer can deduct all ordinary, necessary, and reasonable expenses associated with the use of his or her own vehicle, i.e., car, van, pickup truck, or panel truck (Rev. Proc. 2010-51, Sec. 3.01), in carrying on a trade or business. The actual vehicle costs include items such as gas, oil, repairs, tires, insurance, registration fees, licenses, and depreciation (IRS Topic No. 510, “Business Use of Car”). These deductible business costs can be computed by electing either the actual cost method or the standard mileage method, but certain rules associated with either method can lead to unwanted tax consequences.
CALCULATION METHODS
Under the actual cost method, a taxpayer can depreciate the total cost of the vehicle under the applicable rules for listed property. Once the vehicle is fully depreciated, the taxpayer can continue deducting all the costs, other than depreciation, associated with the business use of the vehicle.
If the vehicle is used less than 100% for business, the taxpayer can deduct only the portion of the expenses associated with the business usage. For example, if the vehicle was used 75% of the time for business and had costs of $12,000 ($4,000 of depreciation and $8,000 in other costs), the deductible business expense would be $9,000 ($12,000 × 75%). And if the vehicle is fully depreciated from prior-year usage, then only $6,000 ($8,000 × 75%) of deductible business costs can be claimed. The point is that under the actual cost method, the deductible depreciation expense is limited to the adjusted basis of the vehicle. It’s critical that the taxpayer maintains good documentation of the costs and depreciation claimed under this method.
The standard mileage method is simpler than the actual method to use and maintain in some respects. It requires a taxpayer to maintain the mileage used during the year for business and then multiply that mileage by the standard mileage rate prescribed by the U.S. Treasury Department. For 2018, the standard mileage rate is $0.545 (54.5 cents) per business mile (Notice 2018-3), of which $0.25 is deemed to be depreciation expense. The depreciation component is relevant when the taxpayer needs to calculate the gain or loss from the sale of the vehicle. Unlike the actual cost method, a taxpayer can continue using the standard mileage rate even when the vehicle is fully depreciated (for example, see p. 24 of the 2017 IRS Publication 463).
LIMITATIONS
There are limitations associated with the use of these two methods. First, Rev. Proc. 2010-51, Sec. 4.05 provides that the standard mileage deduction may not be used if the taxpayer: (1) computes the deductible costs of five or more vehicles he or she owns or uses simultaneously in the business (such as fleet operations); (2) is leasing the vehicle and doesn’t use either the standard mileage rate or a fixed and variable rate allowance for the entire lease; (3) claimed depreciation other than straight-line; or (4) is a rural mail carrier working for the United States Postal Service who receives qualified reimbursements.
Second, a taxpayer who elects the actual method in the first year of the vehicle’s service can’t switch to the standard mileage method in a later year. But a taxpayer who elects the standard mileage method in the first year can annually select the method that provides the greater deductible expense in the subsequent years. The restriction, however, is that straight-line depreciation must be used from that point forward over the vehicle’s remaining life (Rev. Proc. 2010-51, Sec. 4.05, and IRS Topic No. 510, “Business Use of Car”).
Third, a taxpayer who is leasing a vehicle and elects to use the standard mileage method in the first year of use must continue to use this method for the entire lease period, including any renewals (IRS Topic No. 510, “Business Use of Car”).
SALE AND DEPRECIATION
When computing the gain or loss from the sale of a vehicle used in the taxpayer’s business, the basis of the vehicle is reduced by the amount of depreciation claimed. In the case where the taxpayer has elected to use the actual cost method, the vehicle’s adjusted basis is part of the annual calculation. In the case where the taxpayer has elected to use the standard mileage method, it will be necessary to determine the accumulated depreciation by rate of depreciation allowed annually in the standard mileage rate. If the taxpayer deducted the actual costs of operating an automobile for one or more years, the business standard mileage rate to determine the amount as depreciation can’t be used for those years.
The depreciation component of the mileage rate per mile is published annually by the IRS. Notice 2018-3, Sec. 4, reports the 2018-year depreciation component to be $0.25 per mile. Each notice provides the rates for the current and prior four years, and IRS Publication 463 provides the same information for an 18-year period.
Here’s an example that shows the calculation of the basis of the vehicle: Jennifer purchases a van for $30,000 in 2013 and uses it exclusively for her business. She determines the vehicle’s deductible business expense using the standard mileage rate. The van’s mileage for each year is 15,000 in 2013, 12,000 in 2014, 10,000 in 2015, 14,000 in 2016, 15,000 in 2017, and 5,000 in 2018, when she sold the van. The depreciation portion for 2013 through 2018 is $16,850, which comes from the van’s mileage for each year multiplied by the respective depreciation rate (see Table 1): [$3,450 (15,000 × $0.23) + $2,640 (12,000 × $0.22) + $2,400 (10,000 × $0.24) + $3,360 (14,000 × $0.24) + $3,750 (15,000 × $0.25) + $1,250 (5,000 × $0.25)]. Thus, Jennifer’s basis for the sale of the van is $13,150 ($30,000 - $16,850).
Now assume the same facts except Jennifer purchases the van for $15,000. In this case, she would still have claimed the same amount of depreciation (i.e., $16,850), but the basis for the sale of the vehicle is $0. The calculation ($15,000 - $16,850) results in a negative amount, but the basis can’t be reduced below zero.
Although the taxpayer has flexibility in which method to adopt for calculating the business expense of a vehicle—as well as the ability to switch between methods—it’s important to appreciate that the methods have different rules and limitations.
March 2019
