The decision to lease versus buy a vehicle is not a “one size fits all” decision. The answer depends on many factors. For example, the vehicle type, vehicle price tag, tax savings, availability of cash, the need and usage of the vehicle, and how long the business plans on keeping the asset.
If you are not a numbers person, the ugliness of the accounting options and detail rules (and their exception) for leasing or buying a vehicle can get overwhelming and confusing quickly. So, let’s leave the numbers dance to the accountants and instead focus our discussion on the information you should be armed with when you sit down with your accountant to discuss the best option for your business.
The two options you have to obtain a business car are purchasing or leasing. Which option you choose to go with is impacted by various reasons. You need to be aware of some car facts that the IRS stipulates. Five of those reasons are briefly mentioned below.
Vehicle Type:
The type of vehicle you purchase or lease may impact your taxes. The IRS “penalizes” businesses for using what they call luxury vehicles. Therefore, paying attention to what type of vehicle your business decides to use is essential.
Car Usage:
Whether you purchase or lease a vehicle, various expenses incurred through using the car are deductible up to the rate used for business activity. For example, if you use your vehicle 80% of the time for business and 20% for personal, you can deduct 80% of allowable vehicle-related expenses.
How much, or if at all, you can deduct depreciation on a purchased vehicle is determined by the percentage of business usage of the vehicle and the vehicle type. Contact your CPA for a better understanding of the rule.
Tax Decisions:
There are two ways you can pick from and use to deduct business expenses related to your business car:
Standard mileage method –
- You cannot use this method if you have 5 or more vehicles in your business.
- The method covers insurance, registration fees, repairs, maintenance, gas, and car washes. Hence, if you choose this method, you cannot deduct any of these expenses as separate business expenses.
- There are other vehicle-related expenses that you can deduct if you use the standard mileage method. These include parking fees, toll fees, depreciation (purchased vehicles only)
Actual expense method –
- The method covers the same expenses as seen under the Standard mileage method plus other costs like interest payments on the car’s loan, assuming a loan was taken to purchase the vehicle.
There are rules for switching between the standard and actual methods from year to year. Please consult your accountant in year 1 of owning the business to discuss which method works for your business.
Vehicle Lease Inclusion:
If your business needs or chooses to lease a luxury car, a scalable amount is subtracted from the total vehicle expenses, reducing the allowable expense total that you can deduct on your Income Statement (or Profit & Loss statement.) Remember that your business is taxed on its annual net income (income minus expenses); hence, you benefit from having a larger expense total. The IRS’s goal here is to discourage businesses from using luxury cars.
Depreciation Recapture:
Depreciation recapture is the gain realized by the sale of depreciable capital property, like a vehicle, that must be reported as ordinary income (or, in rare situations, capital gain income) for tax purposes. Without getting too deep in the weeds and avoiding the numbers dance, just remember that when you sell (or trade-in) a car, the amount you get, whether money or trade-in value, is considered for depreciation recapture when you sell the vehicle. Why is this important? Because it impacts your business’s cash flow.
There are more than these five points that impact if you should purchase or lease a vehicle. However, they provide a great starting point for conversing with your CPA. If you do not have a CPA you can talk to; please call our office at NaRfula Financial @ (314)-627-2660; we would be happy to help you make the right choice for your business.
DISCLAIMER: The information provided herein does not constitute the provision of legal advice, tax advice, accounting services, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional legal, tax, accounting, or other professional advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation and for your particular state(s) of operation.
