Tax Planning and Compliance

Buying Or Leasing A Vehicle – That Is The Question

 

Have you ever found yourself in a situation where you are working with the auto dealer to take delivery on your brand-new car and one of the questions asked by the sales rep is whether you want to purchase or lease the vehicle?

The cost of an automobile is a significant business expense and the decision to buy or lease a new vehicle can have tax consequences. As a general rule, buying will typically make more economic sense than leasing. However, the tax conse-quences associated with buying vs. leasing a vehicle can sometimes tip the balance in favor of leasing.
As such, you should think about these various questions when determining whether it is better to buy or lease:

1. Are you self-employed or an employee?
2. Do you plan to drive more than the normal mileage cap per year?
3. How many miles do you drive for business?
4. How many commuting miles do you drive?
5. What percentage of the total use of that vehicle would be for business?
6. How long do you normally keep your vehicle?
7. Do you mind having monthly payments for the rest of your life?
8. How frequently do you service your vehicles?
9. How much money can you afford to put down on a vehicle?
10. If you lease, how much of a deposit is required?
11. How good are you at keeping detailed records?

These are but some of the questions that you need to consider to assist you in determining whether to buy or lease.

For example, in most leases, if you drive more than the normal mileage cap per year, you are penalized for the excess mileage. This could be anywhere from 10 to 25 cents per mile for miles over the mileage cap. So make sure you take into account the additional cost for the excess mileage which at times can become quite expensive.

You may find that leases have a very low monthly payment, yet the down payment is almost as much or more than the down payment to buy the vehicle. This would make the total cost over the life of the lease less attractive, especially when you must return your leased vehicle, typically at the end of two to four years, under most lease agreements. This would result in a lot of down payment money for something that you would never own.
If you tend to keep vehicles for a longer period of time, buying may be preferable. The cost associated with the vehicle will be reduced once you have completed your pay-off of your monthly principal and interest payments and can spread the cost of the vehicle over a longer life.

For cars used in your business, the IRS permits you to use either the mileage rate (36.5 cents per mile for year 2002) or the actual expense method to figure your vehicle expense deduction. When leasing, you may only use the actual expense method. For leased vehicles, this will include the monthly lease payment, gasoline, repairs and maintenance, washes, insurance, and other licensee fees, less the lease inclusion amount. It is still necessary to maintain mileage logs to determine what percent of actual expenses you will be able to deduct, based on the business (as opposed to personal) use of that vehicle.

Another item to note has to do with trade-in vs. sale of your business vehicle. Typically, the trade-in value of an old vehicle is less than its cost basis after depreciation. As a result, the loss on the exchange is not deductible if you trade in your old vehicle for a new one. Instead, the loss up to the amount of business use is added to the cost basis of the new vehicle, allowing the taxpayer to take additional depreciation over the life of the new vehicle. As an alternative, you may want to consider selling your old vehicle when you buy a new vehicle instead of trading in that vehicle in order to avail yourself of that deductible loss on the sale.

One final note has to do with deducting the depreciation on a business vehicle that you own vs deducting the lease payments on a leased vehicle. There are specific dollar amount limits that apply to annual depreciation deductions. The annual depreciation limits depend on the date on which the vehicle is placed into service. In addition, these caps, as provided by the IRS, are based on 100% business use of the vehicle. Thus if you use the vehicle for business at less than 100% then you need to factor that into your calculation.

Also, due to the Jobs Creation and Workers Assistance Act of 2002, there is available an additional first year 30% bonus depreciation cap of $4,600 for vehicles that qualify for the bonus depreciation. This bonus depreciation is in addition to the first year regular depreciation cap which for vehicles placed into service in 2002 is $3,060. Thus you could have an overall first year depreciation cap of $7,660.

In addition, if you financed the purchased vehicle, then the interest portion of your monthly loan payments would also be a deductible item, subject to the percentage of business use of the vehicle.

In order to prevent the avoidance of depreciation caps on purchased vehicles as explained above by leasing a vehicle instead, the IRS applies a limitation on the deductibility of the monthly lease payments. Under this approach, the lessee may be required to include an amount in gross income, based on the price of the car, to offset the rental lease payment deductions. The IRS has established annual lease tables to reflect what this amount would be based on the vehicle’s fair market value. You can obtain this amount from your tax advisor.

Before you make a decision to trade in your old car, sell it, purchase a new vehicle, or lease one, you should consult your tax adviser for the best approach in your particular tax situation.