Tax Breaks for Self-Employed Individuals Who Use a Vehicle for Business
Generally, you can claim deductions for vehicle expenses as a self-employed taxpayer, but the tax law includes several limits that can affect your write-offs. The rules for purchased and leased vehicles are similar, with some significant differences.
You may deduct vehicle expenses in one of two ways for owned and leased vehicles:
1. Actual expense method: This method allows you to deduct your actual expenses based on the percentage of business use. For example, if you use a car 75% for business and drive it 25% personally, you may write off 75% of your qualified expenses, including gas, oil, insurance, repairs, etc. You are also eligible for depreciation deductions, subject to certain limits.
2. Standard mileage rate: the simplified standard mileage rate is set annually by the IRS. For 2021, the standard mileage rate is 56 cents per business mile (down from 57.5 cents in 2020). You can also deduct business-related tolls and parking fees. For example, if you drive a vehicle 10,000 business miles and incur $500 in parking fees and tolls this year, your deduction is $6,100 (56 cents x 10,000 + $500).
Under either method, the IRS requires that you keep detailed contemporaneous records as proof in case the IRS challenges your deductions. You must record each business trip, including the date, location, distance and business purpose. The record-keeping for the actual expense method is more burdensome because you must account for every deductible expense (gas, insurance, etc.)
For cars that are purchased the actual expense method will often produce a bigger annual deduction from the rules associated with depreciation deductions. However, the tax law imposes “luxury car” limits to prevent excessive deductions.
You can claim a current deduction under Section 179 up to the annual luxury car limits. For a passenger car placed in service in 2021, the limit is $10,200. Then you are entitled to a deduction in succeeding years under cost recovery tables.
You can claim a first-year bonus depreciation deduction. Currently, the maximum deduction for a passenger vehicle is $8,000.
Note that the actual deduction amounts are based on the percentage of business use. In our prior example, if you’re entitled to a $10,000 maximum Section 179 deduction for a car and you use it 75% for business, your deduction is $7,500.
If you lease a vehicle for use in your business, you will be able to deduct the lease payments from your taxes as a business deduction. Again, the amount of your deduction is based on the amount paid and the percentage of business use. If you made a down payment on the car, you cannot simply deduct this down payment from your taxes right away. Instead, the deduction for the down payment must be spread over the life of the car. In addition, you may have to reduce the amount of lease payments you claim as business expenses if your car lease is more than the annual limit. Similar to purchased vehicles, there is a limit on the deduction for “luxury” vehicles. For leased vehicles, this is the “inclusion amount”. Further details can be found at Publication 463 (2020), Travel, Gift, and Car Expenses | Internal Revenue Service (irs.gov)
Other special rules may come into play. For instance, if you buy a heavy-duty SUV or pickup truck instead of a passenger vehicle, you may qualify for a deduction of up to $25,000. A special tax credit for electric cars of up to $7,500 also may be available. See your tax advisor for more details.
When you dispose of your car, you may have a taxable gain or a deductible loss. The portion of any gain that is due to depreciation (including any section 179 deduction, clean-fuel vehicle deduction (for vehicles placed in service before January 1, 2006), and special depreciation allowance) that you claimed on the car will be treated as ordinary income. However, if you trade-in your car for a new one, the transaction is considered a like-kind exchange. Generally, no gain or loss is recognized. (For exceptions, see chapter 1 of https://www.irs.gov/pub/irs-pdf/p544.pdf ) In a trade-in situation, your basis in the new property is generally your adjusted basis in the old property plus any additional amount you pay.