This article is part of the End of Year Tax Tips Series from tax and legal expert Mark J. Kohler.
It’s not uncommon for business owners to make big purchases before year-end to get the tax write-off. This couldn’t be more true when it comes to buying a car, truck, RV or van for your business. However, making that big purchase isn’t always the best long-term tax decision, not to mention the wisest economic decision. Both are critical issues that I will explore below.
Essentially, there are two main options to write off auto expenses: mileage or actual. The mileage method is quite obvious, but the definition of "actual expenses" can get a little complicated. In fact, the actual method can encompass leasing a vehicle, as well fuel, insurance, repairs, maintenance and even depreciation. But before we get into the strategy of strolling into the auto dealership on Dec. 31 to buy that new car or truck, let's get down the basics.
The mileage method
On any of your vehicles, you can use mileage as an excellent method to expense the business use of your vehicle. In 2016, potential mileage deductions are as follows:
- Business: $0.54/mile
- Charity: $0.14/mile
- Medical and moving: $0.19/mile
- Personal or commuting: No deduction
Ninety percent of my tax clients use mileage because it’s simple, easy and a large deduction. For instance, keep in mind that a car payment is not a deduction. When you compare mileage to "actual," it's important to understand what is "actually" deductible if you use the actual method.
The second method in deducting automobile expenses is to write off actual expenses for the vehicle. You will now need to track your fuel, repairs, maintenance, insurance and tires, as well as “depreciate” the vehicle or a portion of the lease payment if leasing.
Related: How to Write Off Startup Costs
At first glance, business owners often think that the actual method is a big write-off because they see all of these expenses going out the door with the car payment; however, the car payment amount is irrelevant in the analysis. Thus, you have to bank on the depreciation deduction to make this strategy really pay off, which is drastically limited with cars but can pay off big time with trucks, SUVs, vans and RVs (see below).
Also, keep in mind that when you choose to use the actual method, you’re now stuck with his procedure and you can’t use the mileage method again with that car -- there is no going back!
Finally, from a bookkeeping standpoint, it’s important to pay for all of the expenses I described above from your business account so that you don’t miss any of them come tax time. Don’t co-mingle the payment of these auto expenses with your personal account. It can be a nightmare to try and dissect.
The pros and cons of depreciation
Again, the problem with the actual method is that the depreciation expense can be tricky to understand and calculate. It will vary dramatically based on the type of vehicle, and the business use percentage still plays a big factor.
For example, depreciation is drastically limited for cars, and even if you buy a big truck, you have to still track mileage to show the percentage you use the vehicle for business.
However, it starts to get better and better when the vehicle weighs more than 6,000 pounds. But keep in mind there are different rules for SUVs and the type of truck you may drive. The exciting part is that this depreciation deduction really opens up for large trucks, vans and RVs in certain instances.
SUV or truck with a bed that's less than six feet. Both of these types of vehicles are treated the same for tax purposes. Yes, Congress and the IRS feel that many of these trucks with shorter truck beds are more like SUVs than trucks, thus they fall into the same tax category.
Now, the allowable depreciation for these types of vehicles, on top of actual expenses described above, is that you can take up to $25,000 as a deduction right off the purchase price, whether the truck or SUV is new or used. You also get to take the standard annual depreciation deduction of around $3,000 in the year of purchase. This little $25,000 write-off is often a perfect fit for a business owner looking for one of these types of vehicles, and it can exceed the mileage deduction in the first few years you own the vehicle.
ECONOMIC TIP: From a dollars and cents standpoint, this strategy really pays off if you indeed want and need one of these types of vehicles -- and you don’t plan on putting a ton of miles on it or trading in the vehicle in three to four years. But for those of you planning to put on a ton of miles or keep the vehicle longer than the average American, the mileage method will give you more bang for your buck in the long run.
Again, keep in mind the business use percentage of the depreciation and all of the actual expenses (fuel, repairs, maintenance, etc.). For example, say you have $20,000 in annual expenses and depreciation, and 80 percent of your use of the vehicle is for business. Thus, you are allowed a $16,000 deduction. Moreover, keep in mind that you have show net income in your business. The extra depreciation can’t put you into a "loss" to deduct against other income.
YEAR-END TIP: Purchase an SUV or truck for your business and take up to a $25,000 deduction right off the top.
Large trucks and vans. If the truck or van weighs more than 6,000 pounds and the truck has a six-foot bed (or greater) or is an enclosed delivery truck, then the $25,000 SUV limitation does not apply. In fact, you can deduct up to $500,000 for the cost of the vehicle in the year of purchase (limited to the business use percentage described previously).
Because of the higher cost of these vehicles, it’s much more likely the actual method will far exceed the mileage method in the long run. This is also because the operational costs, such as gas and repairs, can be higher with these more expensive types of vehicles. Though again, keep in mind that these large depreciation deductions in the first year are limited to your net income. Therefore, a more profitable or seasoned business is going to get a better write-off than a company in startup mode that is not showing a profit yet.
Business equipment. It probably goes without saying, but it’s important to note that businesses that plan to make big equipment acquisitions in early 2017 may want to purchase this equipment before Dec. 31, 2016. This is a very common strategy for a farmer buying a tractor or a doctor buying an x-ray machine, for example.
The depreciation deduction in the first year can be up to a whopping $500,000 of the purchase price, and even if you buy the equipment on credit and don’t make a payment until 2017, you still get the tax write-off in 2016.
Recreational Vehicle (RV) strategies. Deducting an RV can be an exciting and lucrative tax strategy. However, the key is the “business purpose” or use of the RV. If you simply have an RV as a second home, you will be limited to the Schedule A itemized deduction for any interest on the loan to purchase the RV. So... think of how you could use the RV in your business.
If the RV qualifies as a business vehicle more than 50 percent of the time, you can treat it as you would a large truck or delivery van and your depreciation deduction in the first year could be as high as $500,000. Think about using the RV for trade shows, visiting specific locations near your customers, picking up supplies, delivering products or traveling to work on your rental properties.
But again, you need to generate income for legitimate business purposes (as is required with any auto, truck, SUV or van deductions). Options for deducting the RV could be either mileage or actual, but it depends on your personal use of the RV and whether or not you are living in the RV full time.
Renting the RV like a traditional rental property or VRBO is becoming an increasingly creative tax and wealth-building strategy. Why not put the RV to work earning cash in a rental pool when you aren’t using it? This strategy allows you to depreciate the RV and take actual expenses including maintenance. Again, your personal use percentage will come into play, but the tax benefits and cash flow can be a significant benefit to the RV owner. Now the RV can be depreciated and treated much like a traditional rental property.
In sum, create a spreadsheet to analyze your own situation before you rush to the dealership to purchase a car or truck. It doesn’t have to be complex, either. Establish columns to compare mileage to purchase and to lease, and your rows can be different types of vehicles and different scenarios.
You can certainly do some initial research and calculations by simply pulling information off the web and then having your accountant or tax preparer fine-tune your analysis. It could save you a lot of money.
If you are going to spend thousands of dollars on a vehicle, it’s valuable to take a few minutes to analyze the various tax deduction options.
Mark J. Kohler is a CPA, attorney, radio show host and author of The Tax and Legal Playbook: Game Changing Solutions For Your Small Business Questions and What Your CPA Isn’t Telling You: Life-Changing Tax Strategies from Entrepreneur Press. He is also a partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP and the accounting firm K&E CPAs, LLP. Check out Mark's YouTube channel or buy Mark’s education products today!