Refresher: Tax Aspects of Vehicle Use for Business

January 22, 2024

In general, if you use vehicles for your trade or business, you can deduct the ordinary and necessary expenses incurred while operating the vehicle.

Here's a refresher on the basic tax rules for the business use of vehicles.

Taxpayers may use either the standard mileage rate method, or the actual cost method to recover vehicle costs. For purposes of these deductions, an "automobile" includes a passenger vehicle, van, pickup or panel truck.

Standard mileage rate vs. actual cost method

In lieu of proving the actual costs of operating an automobile, self-employed individuals may compute the deductible costs for their business use of an auto using a standard mileage rate. The standard mileage rate may also be used to reimburse employees who use their own car for business. Businesses that operate up to four vehicles at the same time can deduct this standard mileage rate rather than keeping track of actual costs. The standard mileage rate for business for 2023 is 65.5 cents per mile and will be 67 cents per mile for 2024. Alternatively, if you use the actual cost method, you may take deductions for depreciation, lease payments, registration fees, licenses, gas, insurance, oil, repairs, garage rent, tolls, tires, and parking fees.

Substantiation

Proper recordkeeping is critical. The recordkeeping requirements vary depending upon which method you use. If you use the standard mileage rate, you should keep a daily log showing the miles traveled, destination and business purpose. Recordkeeping under the actual cost method is somewhat more onerous. You should also keep a mileage log if you use the actual cost method to establish business use percentage. In addition, you must keep receipts, invoices, and other documentation to verify expenses. Finally, you must be able to prove the original cost of the vehicle and the date it was placed in service for business use to claim depreciation.

Personal vs. business miles

Regardless of the method used, if the vehicle is driven for personal as well as business purposes, only expenses or mileage attributable to the percentage of business use are deductible. If you use your vehicle more than 50 percent for business during the year, you can pro-rate your deduction. You also have the option of using the standard mileage rate, based on miles of business use for the year times the prescribed rate.

Automobile depreciation and annual limits

The depreciation deductions for passenger automobiles are subject to annual limitations for the year the taxpayer places the passenger automobile in service and for each succeeding year.

Bonus depreciation

A taxpayer who acquires a business vehicle after September 27, 2017, and places the vehicle in service before 2023 is entitled to a 100 percent bonus depreciation deduction in the placed-in-service year. Beginning in 2023, the bonus depreciation rate is 80 percent and decreases by 20 percent each year until it reaches zero in 2027, and therefore will be 60 percent for 2024. Under the luxury car rules, the actual bonus deduction for the year is limited to the first-year cap (e.g., $20,200 for a vehicle placed in service in 2023). NOTE: The IRS has not yet published the 2024 depreciation limits for vehicles used in business.

However, without adopting an IRS safe harbor, no depreciation deductions may be claimed in any of remaining years of the vehicle’s regular depreciation period. This is because the basis of the vehicle for purposes of computing depreciation during the remaining years is partially reduced if the taxpayer had claimed the bonus depreciation deduction. The amount of the bonus depreciation deduction in excess of the first-year cap is recovered at a specified rate per year beginning with the first year after the last year in the vehicle’s depreciation period ($6,960 for a vehicle placed in service in 2023).

This computational “quirk” may be avoided by adopting the IRS safe harbor method of accounting in the first tax year after the placed-in-service year. Under the safe harbor, a taxpayer deducts the first-year depreciation limit ($20,200 for 2023) in the placed-in-service year. In each subsequent year of the depreciation period, the taxpayer claims the depreciation deduction allowed by applying the applicable depreciation table percentage for the year to the cost of the vehicle as reduced by the first-year limit. However, if the depreciation cap for the year is less than this amount, the deduction is limited to the depreciation cap.

Section 179 deduction

A new or used vehicle may qualify for expensing under Code Sec. 179 in the tax year that it is placed in service if business use of the vehicle exceeds 50 percent. However, the sum of the section 179 expense deduction and regular first-year depreciation deduction (including any bonus depreciation) cannot exceed the applicable first-year depreciation cap for that vehicle.

Certain heavy vehicles not subject to limits

Sport utility vehicles, trucks, and vans with a gross vehicle weight rating (GVWR) greater than 6,000 pounds are not subject to the annual depreciation caps imposed by the listed property luxury car rules because they are excluded from the definition of a passenger automobile. This can provide a tax break for buying new or used heavy vehicle that will be used over 50% in your business.

New and used clean vehicle credits

There are potential opportunities for taxpayers who purchase electric or fuel cell vehicles after December 31, 2022, and before January 1, 2033. The limitation on the number of vehicles produced by a specific manufacturer is no longer required. However, the credit imposes sourcing requirements on the critical components of the vehicle and battery systems. The maximum amount of the credit remains at $7,500, but includes income limitations, as well as limitations on the manufacturer’s suggested retail price. Additionally, a new credit of up to $4,000 is also available for the purchase of a previously owned clean vehicle, subject to income limitations, through 2032. Eligible vehicles must satisfy several tests, including energy savings standards.

The credits are generally nonrefundable personal credits; however, any portion that is attributable to depreciable property is part of the general business credit.

For more information, refer to our prior blog, "Tax considerations for vehicle operation in inflationary times”