New Vehicle Purchase - Whether to Buy or Lease

By Peter Jason Riley

If you are planning to lease or purchase a new vehicle in the near future, especially in connection with your business, the tax considerations should not be overlooked. Depending on the type of the vehicle, its anticipated use, and whether you buy or lease, significant tax implications can result. This letter is meant to give you a basic idea of points you might consider before heading out to the dealership.

The cost of a vehicle used in a trade or business is usually deductible, at least in part. The question is how that deduction can be maximized in any particular case.

There are two ways to recoup acquisition cost and operating expenses: the standard mileage rate, or the "actual expense" method. The standard mileage rate is set at regular intervals by the IRS to account for new vehicle prices, insurance, fuel costs, repair and maintenance costs and the like. The standard business mileage rate is 48.5 cents per mile for 2007 (50.5 cents in 2008). To use this method, you simply need to keep a log of business use and miles driven and multiply the mileage for the year by the rate. The standard mileage rate is the same whether you buy or lease your vehicle; and whether it is brand new or 10 years old.

Using the "actual expense" method can be a little trickier but frequently is worth the extra effort. The IRS depreciation tables depreciate the purchase price of a business vehicle over six years. If you are leasing instead, the IRS has "lease inclusion" tables that, in effect, mirror the depreciation benefits.

In both the buy and lease situation, writing off acquisition costs almost always runs into the "luxury automobile" limitations. These limits in effect assume that the value of the vehicle is no more than about $15,500. For vehicles purchased in 2006, that assumption results in a maximum depreciation write-off of $2,960 for the first year, $ 4,800 for the second year, $2,850 for the third year, and $1,775 for the fourth year and each year thereafter (the caps for trucks and vans are slightly higher). Lease payments are similarly restricted through IRS's lease inclusion tables.

A word about the much publicized SUV loophole. It's been severely restricted. The American Jobs Creation Act of 2004 (Jobs Act of 2004) included an amendment to limit the property expensing deduction for luxury sport utility vehicles (SUV's) to $25,000 (it had been $100,000). This amendment is effective for property placed in service on or after October 22, 2004. Regular passenger automobiles and trucks were never allowed to "expense" any portion of its purchase price. The $25,000 expensing limit applies only to SUVs with truck chassis and gross weight of more than 6,000 pounds. If you are looking to acquire a vehicle with this profile, buying rather than leasing likely would be the better route since expensing is not reflected in the lease rules.

If the vehicle is used for both business and pleasure, the amount of the depreciation is limited to the actual amount for business use. For example, a vehicle that is used two-thirds of the time for business may only take the depreciation deduction for 66.67 percent of the actual percentage allowed. For the year the vehicle is placed in service, this would be 13.334 percent of the vehicle's value. If a vehicle is used less than 50 percent of the time for business, the vehicle must be depreciated using another method called the straight-line method.

The deductibility of operating expenses, such as gas, oil, tires, insurance, repairs and maintenance is the same under the actual method whether you decide to buy or lease.

Another factor to consider in deciding whether to buy or lease is whether to use an alternative, efficient-energy vehicle. Beginning in 2006, buying or leasing a special non-gasoline vehicle can save you additional amounts on your tax bill. More often than not, the type of vehicle to consider is a gasoline-electric hybrid vehicle, since those are most readily available from dealers, and are available in the widest variety of sizes and styles.

Through December 31, 2005, a tax incentive is available for non-gasoline powered vehicles, including gasoline-hybrid electric vehicles. The incentive is a $2,000 deduction for any hybrid accepted by the IRS as fuel efficient (the IRS has a list available, or you may contact us, and we can help you find the one that is right for you). Starting January 1, 2006, the incentive becomes a credit under the "Alternative Motor Vehicle Fuel Credit," for up to $3,400 for passenger vehicles, and much more for other types of vehicles. No business use is required for either tax break. In both instances, however, the tax break is available for a new vehicle purchase only. Leasing the vehicle doesn't qualify. Nevertheless, the leasing company gets the tax break, so at least hypothetically its tax windfall should be reflected at least in part in the form of overall lower lease payments for you.

There are many tax benefits available for vehicle use in business. Of course, with the benefits are many fine-point rules that must be followed. Give our office a call today. We are here to help you make a decision on whether to buy, lease or sit tight for a while based on the tax factors involved and how they apply to your particular tax situation.