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Vehicle Depreciation and Deductions

November 20, 2023



In general, if you use vehicles in pursuit of a trade or business, you can deduct the ordinary and necessary expenses incurred while operating the vehicle. Taxpayers may use either the standard mileage rate method or the actual cost method to recover vehicle costs. For purposes of these deductions, an "automobile" includes a passenger vehicle, van, pickup or panel truck. (For more information on the Personal and Business Use, Section 179 Deduction and Luxury Vehicle, please refer to the October Newsletter "Maximizing Deductions for Business-Use Vehicles".)

Standard mileage rate vs. actual cost method

In lieu of proving the actual costs of operating an automobile, self-employed individuals may compute the deductible costs for their business use of an auto using a standard mileage rate. The standard mileage rate may also be used to reimburse employees who use their own car for business. Businesses that operate up to four vehicles at the same time can deduct this standard mileage rate rather than keeping track of actual costs. The 2023 standard mileage rate is 65.5 cents per mile and for 2022 is 58.5 cents per mile for business. Alternatively, if you use the actual cost method, you may take deductions for depreciation, lease payments, registration fees, licenses, gas, insurance, oil, repairs, garage rent, tolls, tires, and parking fees.

Substantiation

Proper recordkeeping is critical. The recordkeeping requirements vary depending upon which method you use. If you use the standard mileage rate, you should keep a daily log showing the miles traveled, destination and business purpose. Recordkeeping under the actual cost method is somewhat more cumbersome. You should also keep a mileage log if you use the actual cost method to establish business use percentage. In addition, you must keep receipts, invoices, and other documentation to verify expenses. Finally, you must be able to prove the original cost of the vehicle and the date it was placed in service for business use to claim depreciation.


Bonus depreciation

A taxpayer who acquires a business vehicle after September 27, 2017 and places the vehicle in service before 2023 is entitled to a 100 percent bonus depreciation deduction in the placed-in-service year. Beginning in 2023, the bonus depreciation rate is 80 percent and decreases by 20 percent each year until it reaches zero in 2027. Under the luxury car rules, the actual bonus deduction for the year is limited to the first-year cap (e.g., $20,200 for a vehicle placed in service in 2023). However, without adopting an IRS safe harbor, no depreciation deductions may be claimed in any of remaining years of the vehicle’s regular depreciation period. This is because the basis of the vehicle for purposes of computing depreciation during the remaining years is partially reduced if the taxpayer had claimed the 80 percent bonus deduction. For the years beginning after the vehicle’s depreciation period, the taxpayer may deduct depreciation at a specified rate per year ($6,960 for a vehicle placed in service in 2023), until the basis is fully recovered.

This computational “quirk” may be avoided by adopting the IRS safe harbor method of accounting in the first tax year after the placed-in-service year. Under the safe harbor, a taxpayer deducts the first-year depreciation limit ($20,200 for 2023) in the placed-in-service year. In each subsequent year of the depreciation period, the taxpayer claims the depreciation deduction allowed. The depreciation deduction allowed is calculated by applying the applicable depreciation table percentage to the cost of the vehicle reduced by the first-year limit ($20,200 for 2023). However, if the depreciation cap for the year is less than the depreciation deduction allowed, the deduction is limited to the depreciation cap. No statement is required to adopt the safe harbor method.


Automobile depreciation and annual limits

The depreciation deductions for passenger automobiles are subject to annual limitations for the year the taxpayer places the passenger automobile in service and for each succeeding year. The passenger automobile limits are the maximum depreciation amounts you can deduct for a passenger automobile. They are based on the date you placed the automobile in service.


Below is a table of depreciation limitations for passenger automobiles acquired after September 27, 2017, and placed in service during calendar year 2023, for which bonus depreciation applies.

Below is a table of depreciation limitations for passenger automobiles placed in service during calendar year 2023 for which no bonus depreciation applies.


New and Used clean vehicle credits

There are potential opportunities for taxpayers who purchase electric or fuel cell vehicles after December 31, 2022, and before January 1, 2033. The limitation on the number of vehicles produced by a specific manufacturer is no longer required. However, the credit imposes sourcing requirements on the critical components of the vehicle and battery systems. The maximum amount of the credit remains at $7,500, but includes income limitations, as well as limitations on the manufacturer’s suggested retail price. Additionally, a new credit of up to $4,000 is also available for the purchase of a previously owned clean vehicle, subject to income limitations, through 2032. Eligible vehicles must satisfy several tests, including energy savings standards.The credits are generally nonrefundable personal credits, so unused credit amounts cannot be refunded or carried forward; however, any portion that is attributable to depreciable property is part of the general business credit and is subject to the carryover rules.

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