Lease vs Buy: Tax Benefits for Your New Car

Lease vs Buy: Tax Benefits for Your New Car

When considering the financial impact of getting that new car for your business/practice, you may find yourself weighing the benefits of leasing versus buying.

The choice can have significant tax implications that require careful examination before you make a decision.

If you listen to Dave Ramsey, he says there’s no way “in you know what” that he’d ever recommend leasing a car. Yet, other financial “gurus” say different. 

So what’s the best?

I’m NOT a CPA, so make sure you check with yours about tax issues for your business or practice.

If you want a free consultation with mine, click HERE.

In this article, we’ll discuss the tax rules for deducting business vehicle expenses, whether you buy or lease a car.

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Overview of Car Leasing vs Buying

Pros and Cons of Leasing

Pros Cons
  • Lower Monthly Payments: Enjoy lower payments than an auto loan.
  • Short-Term Commitment: Drive a new vehicle every 2-4 years.
  • Warranty Coverage: New vehicles under manufacturer’s warranty.
  • Residual Value: No worry about depreciation.
  • Mileage Restrictions: Penalties for exceeding limits.
  • Customization Limits: Cannot significantly customize the vehicle.
  • End-of-Lease Costs: Charges for wear and tear or other settlements.

Pros and Cons of Buying

Pros Cons
  • Ownership: The vehicle is yours, with freedom to keep or sell.
  • No Mileage Limits: Unlimited driving without mileage penalties.
  • Customization: Freedom to customize your vehicle as you wish.
  • Higher Monthly Payments: Loans often result in higher payments than leasing.
  • Long-Term Commitment: Car loans typically last 5-7 years.
  • Depreciation: New vehicles depreciate quickly, affecting resale value.
  • Out-of-Pocket Repairs: Responsible for all repair costs post-warranty.
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Tax Implications for Business Owners

When using a vehicle for business purposes, the tax benefits can differ significantly between leasing and buying. Your choice can impact your overall tax deductions and the cost-effectiveness of the business vehicle.

Leasing for Business Use

When you lease a vehicle for business use, you may deduct the lease payments as a business expense. However, the portion of the payment that corresponds to personal use can’t be deducted.

For example, if you use the leased vehicle 70% for business trips and 30% for personal use, then only 70% of the lease amount is deductible.

To further clarify, the IRS allows you to deduct actual expenses or use the standard mileage rate for business miles driven. Here’s how it works:

  • Lease Payments: Fully deductible based on the percentage of business use.
  • Standard Mileage: As an alternative, you can choose to use the current standard mileage rate for the business miles driven.

Remember: You cannot switch between methods from year to year with a leased vehicle.

Buying for Business Use

On the other hand, when buying a vehicle for business, you can take advantage of deductions like depreciation, including the Section 179 deduction if eligible, which can lead to significant tax savings. The vehicle must be used more than 50% for business purposes to qualify.

Here are specific points to keep in mind:

  • Depreciation: You can claim depreciation on the company car, taking into account the business-use percentage.
  • Section 179 Deduction: Small business owners may deduct the cost of the vehicle in the year of purchase up to the limits set by the IRS.

Records to Maintain: Maintain logs of business miles, as well as records of actual expenses to maximize your business deductions. Deductions must be allocated between personal use and business use based on the percentage of business miles compared to the total miles driven.

Note: Actual expenses include gas, insurance, repairs, and maintenance, and you can deduct these expenses proportionally based on the business use percentage.

The Basics of Section 179 and Bonus Depreciation

Section 179 and bonus depreciation are two parts in the tax code that let you treat the cost of certain business assets, like vehicles, as an expense as soon as you start using them.

Instead of spreading out the cost over several years, you can deduct a large part, or sometimes even all, of it in the same year you place it into service. This can lead to some serious tax savings, but there are specific rules to follow.

The IRS sorts vehicles into three main categories:

#1. Cars

 This includes any four-wheel car, truck, or van designed mainly for driving on public roads with an unloaded weight of 6,000 pounds or lighter. For 2024, the max first-year deduction you can take is $19,800.

#2. SUVs

We’re talking about any four-wheel drive vehicle weighing between 6,000 and 14,000 pounds. There’s no limit on bonus depreciation for SUVs and the biggest first-year Section 179 deduction you can snag is $27,500 in 2024.

#3. Other Heavy Vehicles

These are the big ones—cargo vans, delivery trucks, buses, etc., with a loaded weight over 14,000 pounds. They can get the full Section 179 deduction, which is a whopping $1,080,000 in 2024.

Even if you drive the vehicle for some occasional personal use, you can still claim a Section 179 deduction, provided it’s used more than 50% for your business. If it’s business use dips below 50%, your only option is to go with straight-line depreciation over several years.

End-of-Term Considerations

When your lease ends or you’re ready to move on from your purchased vehicle, understanding the financial implications is important to making a smart decision.

Terminating a Lease

At the end of the lease, you need to be aware of certain financial responsibilities.

The lease inclusion amount could affect the taxes you pay on a leased vehicle, which is a calculation based on the fair market value of the vehicle.

Another key figure is the residual value, which is the predetermined buyout price at the end of your lease term.

Make sure to check for any additional charges for excessive wear or mileage overages.

If you choose to return the vehicle, you’ll conclude your dealings with the service provider by either walking away or transitioning to a new lease or purchase.

Selling or Trading a Purchased Car

When you decide to sell or trade-in your purchased car, the sale price will generally reflect the market value of the vehicle at that specific point in time.

It’s advantageous to keep the vehicle in good condition to maximize resale value, helping to avoid losses due to depreciation. Here are some points to consider:

  • Sale Price: Research the fair market value to set a competitive price or understand trade-in offers.
  • Service Records: Having a complete set of service records can increase your car’s value to buyers.
  • Market Trends: Be aware of how your car’s value is influenced by the current market demand.

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Electric and Hybrid Vehicle Incentives

If you’re considering an electric vehicle (EV) or hybrid for your business, you’re potentially eligible for significant tax credits.

The federal government provides a tax credit up to $7,500 for qualifying electric and hybrid vehicles.

However, these incentives phase out once a manufacturer sells 200,000 qualifying vehicles, so your choice in brand may impact your eligibility for this credit.

Tax Cuts and Jobs Act of 2017

Your business vehicle acquisition is also influenced by the Tax Cuts and Jobs Act (TCJA) of 2017.

This act increased the depreciation limits for passenger vehicles.

If you’re purchasing a new or used vehicle for business use, the TCJA allows larger depreciation deductions in the first year.

Additionally, the act expanded the definition of Section 179 expenses, enabling businesses to immediately deduct the cost of certain vehicles, which now includes certain used property as well.

Be sure to confirm whether the vehicle you’re considering qualifies for these expanded deductions.

Detailed Tax Breakdown for Leasing vs Buying

When considering the tax implications of acquiring a vehicle for business use, it’s essential to understand the difference in benefits between leasing and buying. Your decision can affect your deductions for vehicle expenses on your taxes.

Lease Payments and Deductible Expenses

When you lease a vehicle, you may deduct your car lease payments as a business expense.

However, the portion of the payment that represents the fair value of the vehicle is not deductible.

For example, if your monthly lease payment is $300 and the inclusion amount that represents the lease value is $50, you can claim a deduction of $250 per month.

You should also be aware that only the business-use portion of your leased vehicle expenses can be deducted.

To calculate this, you must determine the percentage of time the vehicle is used for business, which then applies to the total lease cost. Here’s a simple breakdown:

  • Business use of vehicle: 70%
  • Total annual lease payments: $3,600
  • Calculable deduction: 70% of $3,600 = $2,520

Actual Cost Method vs Standard Deduction

The Actual Expense Method allows you to deduct the actual expenses incurred from the use of your vehicle for business.

This includes not only your lease payments but also gas, oil, repairs, insurance, and depreciation (subject to certain limits).

To use this method, you must keep detailed records of all your vehicle-related expenses.

Alternatively, the IRS offers the Standard Mileage Deduction, which simplifies deducting vehicle expenses.

For 2023, the rate is 67 cents per mile driven for business. Here’s an example calculation:

  • Business miles driven: 15,000
  • Standard mileage deduction: 15,000 miles x $0.67/mile = $10,050

Choosing between the actual expense method and the standard deduction requires comparing the total of the actual expenses with the amount from the standard mileage rate to see which provides a higher deduction.

Frequently Asked Questions

What specific tax deductions can one obtain when leasing a vehicle for personal use?

Leasing a vehicle for personal use typically does not provide tax deductions. Personal auto lease payments are not deductible on your personal income tax return.

How do the tax implications compare when deciding to lease or buy a vehicle for business purposes?

For business purposes, leasing can offer immediate tax deductions as lease payments are considered a business expense.

In contrast, buying a vehicle allows for depreciation deductions, which can offer a larger tax break in the first year but spread over the asset’s useful life.

Can leasing a luxury vehicle offer any distinct tax advantages over purchasing one?

Leasing a luxury vehicle may offer tax advantages such as the ability to deduct the full amount of the lease payments as a business expense, circumventing the depreciation limits set for luxury vehicles when purchased.

How does leasing a car impact tax deductions for an S-corporation?

An S-corporation can deduct the cost of leasing as a business expense, but the amount deducted may be subject to income inclusion if the leased vehicle’s value exceeds certain IRS thresholds.

What are the potential downsides from a tax perspective when leasing a car rather than buying?

One downside of leasing is that you may miss out on certain tax benefits like Section 179 deductions and bonus depreciation available when purchasing a vehicle for business, which can significantly lower your taxable income in the year of purchase.

Does leasing under an LLC provide better tax benefits compared to a personal lease or purchase?

Leasing under an LLC can provide better tax benefits if the vehicle is used exclusively for business, as lease payments can be fully deductible.

Conversely, leasing or purchasing for personal use typically offers no tax benefits.