If you use a leased car for business purposes, you can deduct some of your leased car expenses. Follow The Ascent's guide to choosing the best way to deduct vehicle expenses.
We'll leave it to The Motley Fool's lenders to decide whether leasing or buying a car is a better option, but regardless of how you got your hands on the keys to your car, you can claim a deduction if you use it for business purposes.
Summary: What is the Auto Lease Tax Credit?
Using a vehicle you own or lease for business use is a deductible expense. Whether you lease it for personal or business use, you can deduct it for transporting supplies from your office to a customer or taking a trip to check out a new retail space.
Deductions for some auto leases can reduce your business's taxable income. The auto lease deduction is just one of many tax credits for small businesses that can reduce your taxes.
How much of a car lease can I deduct?
In many cases, business owners' personal cars are also used for business purposes. They deduct expenses for the miles driven for business purposes. However, personal travel, including commuting, cannot be deducted from business tax. That's right. Commuting does not qualify as business travel.
There are two ways to deduct expenses on a leased car: actual cost and standard mileage rate. The method you choose at the start of your lease is the method that will last until you return the car to the dealer, so choose carefully.
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Car depreciation is only allowed on owned, not leased, vehicles. Certain leased cars qualify for the Section 179 vehicle deduction, which may allow you to take a first-year deduction in excess of your actual lease cost for that year. However, you will give up your right to deduct the cost of the leased car for the remainder of the lease.
Before taking the Section 179 route, consult with a tax professional about the tax implications. You probably won't get the greatest tax savings that way.
1. Actual cost payment method
As the name suggests, you deduct the actual cost of leasing a vehicle. Expenses you can deduct include lease payment, gas, oil, tires, maintenance, registration, insurance, etc. Keep track of your receipts for these.
If you drive your car for personal travel, you cannot deduct the full cost of a leased car. Calculate the percentage of your total annual mileage that you drive for work, excluding commuting.
For example, say you lease a car and your annual payment, gas, and insurance costs $8,000. You drive the car 12,000 miles, a quarter of which is for personal travel and commuting. Your business deduction would be three-quarters of your actual cost, or $6,000 ($8,000 x 0.75).
2. Standard mileage rates
More simply, you can take a flat-rate deduction for each mile you drive on business in a leased vehicle. Taxpayers often choose the standard mileage rate method because it requires less calculation effort.
IRS mileage fees change slightly each year: in 2019 the rate was $0.58, and in 2020 it will be $0.575.
Continuing with our previous example, if you drive a leased car for business purposes 9,000 miles, you'll deduct $5,175. [(12,000 miles − 3,000 personal and commuting miles) × 0.575 IRS mileage rate].
Which car lease amortization method is better?
You'll need to perform an analysis to choose the car lease depreciation method that will produce the highest deduction. Because you can't change the car lease depreciation method, consider your mileage and car-related expenses over the entire lease term, not just the first year.
Predicting how you'll use your car and what costs will incur is like planning for the future: even if you have a vague idea of what will happen, it could be horribly wrong. Keep that in mind as you do this exercise.
1. Estimate the distance you drive for personal and business purposes
You can only deduct the cost of using a car for business purposes – your daily commute doesn't count as business mileage. When estimating how many miles you'll drive during the lease, take into account business trips, errands, client visits, etc.
Financial projections can help you estimate your annual mileage. For example, say you're opening a new store in a neighboring state. You expect to spend a lot of time in your car over the course of your three-year lease, so you estimate the following:
Your mileage estimates show that your car is used 80% for business and 20% for personal use (60,000 business miles ÷ 75,000 total miles). You'll need this for Step 3.
2. Estimate the IRS standard mileage deduction
Although the IRS can change mileage rates from year to year, there is no way to predict future rates. Use the current year's standard mileage rate to estimate your annual IRS mileage deduction. Then multiply your estimated business mileage by the current year's IRS mileage rate to get your estimated deduction.
The IRS mileage deduction over the life of the lease is estimated to be $34,500.
3. Calculate the cost of leasing a car
Add up all the expenses associated with your leased car, including lease payments, insurance, gas, repairs, etc. Don't include parking fees and tolls, as these are deductible separately.
The cost of the personal parts of the vehicle are also included in the calculation.
Under the actual cost method, you can expect to deduct $31,200 in car lease expenses.
4. Choose how to win
After comparing the results of steps 2 and 3, choose the method that gives you the highest deduction. In this example, there is a slight advantage to choosing the IRS Standard Mileage Deduction Method (IRS Mileage Deduction Method of $34,500 vs. Actual Expense Deduction Method of $31,200), but the difference is not significant enough to be decisive.
If both methods give similar results, as is the case here, you're not necessarily getting any closer to choosing the best method. I would choose the standard mileage rate method because it's easier to implement than the actual cost method.
It’s always best to consult with a tax professional to determine what is the best way to reduce your small business’s tax burden.
How to deduct sales tax on car leasing
If you deduct your auto lease using the actual expense method, you deduct the monthly sales tax on a separate line on your business tax return. If you choose the standard mileage rate deduction, you can skip this step.
If you're a sole proprietor or single-member LLC, you report and deduct auto lease sales tax on Form 1040 Schedule C. Report gas, repairs, and insurance expenses on line 9 and auto lease payments on line 20a. Report auto lease sales tax on line 23.
Sales tax and lease fees are reported separately from other car expenses. Image source: Author
Tax software can guide you through the steps to fill out your Schedule C correctly.
Beep beep! Tax deductions are coming!
If you only use your car occasionally for business, it might not immediately occur to you to deduct part of your lease payments. But don't stop there, consider other self-employed tax deductions you may have missed.
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