Complete Guide to Your Business Vehicle – Buying vs. Leasing, Standard Mileage Deduction vs. Actual Expenses Deduction with Depreciation
If you’re looking for a comprehensive guide to your business vehicle, you’ve found it. In the following article, we cover the pros and cons of buying and leasing a company vehicle and discuss which circumstances are best for buying and leasing. We also review the standard mileage deduction, as well as the actual expenses deduction with depreciation, and point out which option may afford you the bigger tax break, depending on your circumstances. Read on to learn more.
Should I Buy or Lease My Company Vehicle?
Whether you choose to buy or lease your business vehicle depends on your individual financial circumstances. Both purchasing and leasing a vehicle offer advantages and disadvantages. Knowing the benefits and drawbacks of buying and leasing a company car can help you make the best decision for your business.
Let’s take a look at the pros and cons of buying a business vehicle.
Pros of Buying a Business Vehicle:
- When you purchase a business vehicle, you are eligible for several tax benefits, including the standard mileage or actual expenses deduction, depreciation deduction, Section 179 deduction, and additional tax breaks for qualified electric and hybrid vehicles.
- Once you own the vehicle, you can customize it however you like, such as adding your business logo.
- You don’t have to worry about mileage limits and associated penalties when you own the vehicle.
- The longer you own the vehicle, the lower your long-term costs will ultimately be. Once the vehicle is paid for in full, you only need to pay for gas, insurance, and maintenance. Eventually, you will no longer have monthly car payments.
- When it comes time to let go of the vehicle, you can sell it on your own terms.
Cons of Buying a Business Vehicle:
- The upfront cost of purchasing a business vehicle is higher, since you need enough money to make a down payment.
- The monthly loan payments from financing your business vehicle are typically higher than monthly lease payments.
- You are responsible for all expenses related to the routine maintenance and repairs of your vehicle.
- When it comes time to let go of the vehicle, you may find the process of selling it, trading it in, or otherwise disposing of it to be a hassle.
- If you depreciate your business vehicle in its entirety, then you may owe a recapture tax when you go to sell it or trade it in.
Now let’s check out the pros and cons of leasing a business vehicle.
Pros of Leasing a Business Vehicle:
- When you lease a business vehicle, you can enjoy the car during its best years, especially if you lease a new vehicle. You may also discover that a premium make/model may be within your budget if you lease instead of purchase. In addition, a leased new vehicle is often covered under the manufacturer’s new car warranty.
- Lease terms typically include additional perks such as free oil changes and basic maintenance.
- Leasing a business vehicle requires no down payment and typically affords lower monthly payments than the monthly payments you would make if you finance a vehicle.
- When you lease a business vehicle, you can choose either the standard mileage deduction or the actual expenses deduction. Your lease payments are tax-deductible business expenses.
- When your business vehicle lease ends, you can simply return the vehicle without the hassle of selling it, trading it in, or otherwise disposing of it.
Cons of Leasing a Business Vehicle:
- Leasing a business vehicle may cost you more money in the long run because you are never without a monthly car payment and have no equity to show for it at the end of the lease agreement.
- Lease contracts include mileage limits. If you exceed the mileage limit on your lease agreement, you will be charged an excess mileage penalty. Fees for excess mileage can range from $0.10 to $0.50 per additional mile.
- If you turn in your leased vehicle with noticeable wear and tear, then you may need to pay additional fees.
- If you can no longer pay according to the terms of your lease, then you will be hit with early termination fees and penalties.
- Customization of any kind on a leased vehicle is generally not allowed, unless you participate in a lease-to-own agreement, in which you can customize the vehicle once you own it.
Here are several questions you should ask yourself when deciding whether buying or leasing a company car is the better option for you:
What is my budget?
First, you will need to determine your budget for a business vehicle.
Do you have enough money to purchase a vehicle outright? If not, then you must choose between financing a purchase or leasing. Your total costs and monthly payments will look quite different in each scenario.
If you decide to finance a business vehicle, then you will need to consider the loan amount, the down payment, the annual percentage rate (APR), and the loan length. All of these factors determine the vehicle’s final price, as well as the monthly payments you will make.
When financing a vehicle, the size of your down payment impacts the cost of the loan as well as the monthly interest rate. In general, a minimum of 20% down payment is recommended for a new vehicle, while a minimum of 10% down payment is recommended for a used vehicle. You must factor in the upfront cost of a down payment if you decide to finance your business vehicle.
In addition, you will need to decide whether the loan amount, length, APR, and terms are realistic for your budget. Go over all the numbers with your business accountant. Make sure you understand the grand total of the purchase over the length of the loan, including interest.
If you decide you cannot afford to buy a vehicle outright or finance one through a loan, then you may determine leasing is the better option for you. As with financing a purchase, you will need to make sure the terms of the lease are realistic for your budget. Review the upfront cost, monthly payments, and any fees and penalties with your business accountant.
How will I use the vehicle?
Next, consider how you will use the vehicle for your business. If you plan on putting a lot of wear and tear on the car, then it may be better to own it rather than lease it in order to avoid fees and penalties at the end of the lease term. In addition, if you want to have the flexibility of using the vehicle as you wish, then you may decide purchasing is better than leasing, as lease agreements typically have restrictions on permitted uses for the vehicle.
How many miles do I anticipate putting on the vehicle?
Finally, it’s important to have an idea of how many miles you plan to drive your company car. Lease contracts come with annual mileage limits and include fees for every mile driven over the annual maximum. If you plan on driving a lot for business, then you may be better off purchasing a vehicle rather than paying the expensive penalties for exceeding your lease mileage cap.
Next, let’s review the standard mileage deduction, as well as the actual expenses deduction with depreciation.
Should I Take the Standard Mileage Deduction or the Actual Expenses Deduction with Depreciation?
The IRS offers two methods for calculating expenses related to your business vehicle in order to save money on your tax bill: the standard mileage deduction and the actual expenses deduction (with depreciation).
The standard mileage rate method for calculating business vehicle expenses is pretty straightforward. Simply track your business and personal mileage for the tax year and determine what percentage of your mileage applies to your business. Keeping a mileage log is an easy way to do this.
The IRS updates the standard mileage rate annually. For 2023, the standard mileage rate is 65.5 cents per mile.
Here are some advantages of using the standard mileage rate method:
- If you do a lot of driving for work, then this method may offer a larger tax deduction.
- If you use the standard mileage rate method the first tax year you use your vehicle for business, then you can switch back and forth between standard mileage method and the actual expenses method in future tax years.
- Recordkeeping is very simple. May apps offer an easy way to keep track of mileage for business and personal use.
- The standard mileage rate method is easier to use compared to the actual expenses method.
Here are a few disadvantages of using the standard mileage rate method:
- The biggest disadvantage of the standard mileage rate method is that it may result in a smaller tax deduction if you don’t do a lot of driving throughout the year.
- You cannot use the standard mileage rate method if you have claimed the Section 179 deduction on your vehicle.
- Although you can use the standard mileage rate method with a leased business vehicle, you cannot use it to deduct lease payments.
- You also cannot deduct depreciation with the standard mileage rate deduction.
- If you switch to the actual expenses method in later years, you cannot use accelerated depreciation. You must use the straight-line method of depreciation.
The actual expenses method is more complex than the standard mileage rate method. You must add up all expenses related to your business vehicle and multiply this figure by the percentage of the vehicle’s business use. Keep detailed records of all business vehicle expenses throughout the tax year, including:
- Lease payments
- Interest on a vehicle loan
- Parking fees and tolls
- Garage rent
- Registration fees and taxes
- License plates
The actual expenses method affords the following advantages:
- If you don’t do a lot of driving for work, then this method may offer a larger tax deduction.
- You can deduct your vehicle’s depreciation using the actual expenses method.
The actual expenses method poses several disadvantages as well:
- The biggest disadvantage of the actual expenses method is that it may result in a smaller tax deduction if you drive a lot of miles for work throughout the year.
- If you choose the actual expenses method for the first tax year you put your business vehicle in use, then you are locked into this method for all future tax years.
- You must keep detailed records of all your business vehicle expenses, which can be an administrative burden.
A note about depreciation…
The Tax Cuts and Jobs Act strictly limits the depreciation deduction for passenger vehicles.
The maximum annual depreciation deduction for passenger vehicles placed in service in 2023 is as follows:
First year vehicle placed in service: $12,200 ($20,200 if $8,000 bonus depreciation claimed)
Second year vehicle placed in service: $19,500
Third year vehicle placed in service: $11,700
Fourth year vehicle placed in service and later: $6,960
You may take bonus depreciation only if you use your vehicle for business at least 50% of the time in a given tax year.
In addition, you must reduce your total depreciation by the percentage of personal use of your business vehicle.
Finally, if you drive your car for business less than 50% of the time in a given tax year, then you may only use the slower method of depreciation, the “straight-line” method. If you drive your car for business more than 50% of the time, then you may use accelerated depreciation, which gives you larger tax deductions in the first couple of years.
Acquiring a business vehicle through buying or leasing and choosing the best method of calculating a tax deduction for business vehicle expenses requires much planning and assessment of your individual financial circumstances.
We always recommend meeting with your CPA to discuss plans for your company car.
The experts at Honest Buck can help you take a look at the financial side of things to make the right choice for your Early Childhood Education business vehicle.
Contact us today.
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