Vehicles are well-known money-eaters—America’s third-biggest expense behind housing and food. The good news is that vehicle costs for business can yield one of your largest expense deductions. Tax rules for claiming car and truck expenses are tricky, but well worth knowing.
Here are the three basic rules:
Rule 1: Keep records – Use a trip or mileage log to record vehicle use (see sample below), and save gas and repair receipts or credit card statements. You’ll need this data when you do your tax return and to prove your deductions in case you ever get audited.
Rule 2: Allocate business/personal use – If you use your business vehicle for pleasure driving, the IRS requires you to keep track of your use. This is really just another record-keeping issue, but it deserves special mention. You can record either your personal miles or your business miles and your total mileage. For your tax return, you’ll need to come up with numbers like “62% business”, leaving 38% personal. IRS auditors can get very testy if you can’t produce backup data.
Note: Minimal personal use, like occasionally heading a few miles out of your way for lunch while driving for business, is not going to excite the IRS—you don’t have to account for it.
Caution: Do you own or lease just one vehicle? As a rule of thumb, if you only have one car or truck, don’t claim over 80% business use and expect it to fly with an IRS auditor. The auditor will suspect that your personal miles are a lot higher than you’re admitting.
Rule 3: Choose a deduction method – You can use the standard mileage method or the actual expense method to deduct your vehicle expenses—whichever gives the bigger deduction. We’ll explain both next. Generally you should run the numbers using both methods and then choose. With tax preparation software or an accountant, this comparison can be done automatically.
You are allowed to switch back and forth between the two methods every year (with some limitations discussed later in “Actual Expense Method”). But before that, let’s talk about the standard mileage method first.
Standard Mileage Method
The absolute simplest way to deduct business vehicle expenses is called the mileage or standard mileage method. You can choose the mileage method whether you own or lease your auto or truck.
To the lazy folks out there: Don’t automatically choose this method until you have considered the second alternative—it could cost you a bundle at tax time, because you can’t deduct any of the purchase price of your vehicle if you use the mileage method. (This is discussed in “Actual Expense Method,” below).
Steps for Using The Mileage Method
Here’s how it works:
Step 1. A t the end of the year, you total up the number of business miles you drove.
Step 2. You enter that number on your tax return and multiply by 48.5 cents (in 2007).
Step 3. You add in the costs of parking, tolls, and any state property taxes paid for the vehicle.
Example: Lie Dharma, a veterinarian, buys a specially equipped GMC pet hospital truck for $25,000 and drives it 10,000 miles to care for the animal kingdom. The doc chooses the mileage method, giving him a deduction of $4,850 for the miles driven (10,000 miles x 48.5 cents). He also spends $350 for highway and bridge tolls, $100 for the property tax portion of his state vehicle registration, and $250 for parking. Tax result: Lie’s total vehicle deduction is $5,550 ($4,850 + $350 +$100 + $250). This assumes that Lie uses the pet hospital van 100% for business.
When you can’t use the mileage method. You must use the actual expense method of deducting vehicle costs instead of the mileage method when any of the following conditions apply:
- You used more than one vehicle in one business simultaneously.
- You used the actual expense method on this same vehicle in prior years, and also claimed an accelerated depreciation method to deduct the cost of this vehicle.
- You used IRC Section 179 to write off all or part of the vehicle’s purchase price (explained in “Section 179).
Actual Expense Method
The actual expense method requires more record keeping, but it is usually well worth it. For most newer vehicles, the actual expense method produces a bigger deduction than the mileage method. That said, the mileage method may produce bigger deductions if you drive a lot in a gas miser or a faithful old clunker.
A good rule of thumb is that if you paid more than $16,000 for your vehicle and don’t drive more than 12,000 miles per year, you’re better off using the actual expense method. But always run the deduction numbers both ways at the end of the year.
Steps To Using The Actual Expense Method
Here’s what you do:
Step 1. Track your operating expenses: gas, repairs, tires, licensing, maintenance, insurance, and so on.
Step 2. Add the depreciation deduction. This gives you your annual tax deduction for your vehicle.
Step 3. If you use the vehicle for personal purposes as well as business, you must determine the percentage-of-business-use figure, such as 62% business use.
Step 4. Multiply the sum of Steps 1 and 2, above, by the percentage of business use.
Now, here’s an example of the actual expense method:
Steffie, wife of Lie Dharma, the veterinarian in the example above, does floral arrangements for weddings. She buys a Dodge minivan for $25,000 (coincidentally, the same amount her hubby paid for his pet hospital truck). Steffie drives 10,000 business miles and spends $700 for gas, insurance, maintenance, and parking—the same as hubby’s out-of-pocket costs. She chooses the actual expense method and uses the van 100% for business. Tax result: Samina gets a depreciation deduction of $3,260. Adding this to Steffie’s $700 operating expenses, she has a total of $3,960 in vehicle deductions. Her husband wins household bragging rights—his vehicle deductions were $5,550 using the standard mileage method.
Tip: Run the math both ways each year and switch back and forth. You may switch between the two methods every year, with two limitations:
- If you use the actual expense method in the first year you use your car in your business, you can’t switch to the mileage method in any later year.
- If you use the mileage method in the first year you use your car in business, you can switch to the actual expense method only if you take straight line depreciation deductions instead of accelerated depreciation deductions.
Record Keeping for Business-Used Vehicles
No matter which method you use to claim auto expenses, you will need to keep accurate records. The best way to keep auto use records is with a logbook, sold at office supply stores. Or just keep a notepad in your glove compartment. If you’re tech savvy, store the vehicle data in a handheld personal digital assistant (PDA). However you do it, whenever you drive a personal car for business, record:
- the date of the trip
- your destination
- your mileage (round-trip), and who you visited and your business relationship with that person.
Also, keep vehicle-servicing receipts showing the mileage at the first and last servicing of the year. This is one way to prove the total annual miles you drive. If using the actual expense method, you should save all of your other car expense receipts, too 🙂.