Tax advantages of leasing vs. buying a car
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As a business owner, you need to put more thought into whether you buy or lease your vehicles than the average driver. All the standard questions to ask whether to lease or buy come into play, but there is an additional consideration — namely, what are the tax benefits?
Tax deductions for business vehicles
When you use a vehicle for business purposes, there are two approaches allowed by the IRS to deduct the associated expenses on your federal tax return. You may use what’s known as the standard mileage rate deduction, or you can opt to use the actual expenses deduction.
You can swap from standard to actual expense from year to year for a purchased vehicle, but you must stay with what you first pick when leasing.
The standard mileage approach allows you to claim miles driven for your business on your federal taxes.
The IRS announces the standard mileage rate that can be used to calculate the deductible cost of operating a car for business purposes every year. For 2023, the rate is 65.5 cents per mile driven for business purposes. This means if you drive 15,000 miles for your business, you can deduct a total of $9,825.
You can deduct state and local sales tax whether you buy or lease a vehicle. But since sales tax is paid upfront for purchases and in monthly increments for leases, the way your business calculates it will differ.
If you choose to itemize your deductions, you can deduct sales tax instead of income tax. Your business must choose one or the other. As with other deductions, there is an upper limit to the amount you can claim. For 2018 to 2025, that amount is $10,000.
You may deduct the cost of monthly lease payments by using the actual expense deduction on your federal tax returns.
The specific amount of the lease payment deduction allowed depends on how much you drive the car exclusively for business. For example, if your monthly lease payment is $400 and the vehicle is used 50 percent of the time for business, you can deduct $200 per month as an expense.
These benefits are only available if you sign on to a standard lease. You are not able to claim a federal tax deduction for monthly lease payments if you take on a lease-to-own contract, meaning you will own the vehicle when the contract expires rather than having to return the vehicle to the dealer.
Car loan interest
Self-employed people and business owners can deduct interest on auto loans from their taxes. You will need to keep a record of every business trip, odometer reading and car loan payment to verify the amount of interest you pay.
Like other deductions, car loan interest can only be included in your taxes if you opt for an actual expense deduction. If your business uses the standard mileage deduction, you cannot deduct the interest you pay toward your car loan.
Only purchased vehicles qualify for the depreciation deduction — and only when the actual expense deduction is used. The method of determining how much your car depreciated over the year is usually Modified Accelerated Cost Recovery System (MACRS).
Like the mileage deduction, the depreciation deduction changes every year. For the 2022 tax year, the maximum depreciation you could deduct was $11,200 for standard depreciation. If you choose the special depreciation allowance, it is up to $19,200 — though it varies widely based on when the vehicle was placed in service.
You should review Publication 946 by the IRS to familiarize yourself with the ways you can depreciate your vehicles and other property as a business owner.
Maintenance and operating expenses
Actual expense rules also include the deduction of other expenses like gas, oil changes, vehicle repairs and tire purchases for your leased or purchased vehicle. If your vehicle needs extensive maintenance or repairs because of business-related use, keep careful record of it. This way, you’ll know exactly how much you spent — and how much your business can save during tax season.
Expense differences between leased and purchased vehicles
The up-front costs may be far less when leasing a vehicle of the same make, model and year compared to buying it. As a business owner, those savings can be redirected to other business needs and investments. Provided you know you will stay within the lease terms for wear-and-tear as well as expected mileage, you may find that the smaller payments open up more cash for your business.
When comparing the same vehicle as a lease versus a purchase, the monthly payments and the initial down payment can be less expensive for a lease. You may also have reduced maintenance costs if your lease covers the cost of routine services like oil changes.
Purchasing wins out when it comes to the fact that you will eventually own the vehicle, while leases have to end eventually — and your business is left without equity. Early termination expenses if you need to end the contract early and excess mileage fees charged if you go over the mileage limits can also add significant costs when it comes to leasing.
Both options come with interest and other fees, so ultimately, it depends on how your business will need to use the vehicle and what type of cash flow your business already has.
Is it better to lease or purchase a business vehicle?
The potential tax benefits are only one of the considerations for business owners. Ultimately, a vehicle purchase or lease is a big expense for your business, so look at the problem from all angles before committing.
Lease contracts typically limit the number of miles the car can be driven to 10,000 or 20,000 miles per year. Once you exceed that limit, the lease may have a penalty of 10 to 50 cents per additional mile. If you drive a great deal for your business, buying a car may be the better move.
Lease agreements also require that the vehicle be kept in good condition. If you fail to keep up your end of the agreement or if there’s excessive wear and tear on the car when you return it, there may be additional charges.
It’s also worth bearing in mind that if you continually lease one car after another, you will always have monthly car payments, unlike when you purchase a vehicle and eventually own the car outright.
On the upside, if you like having access to the newest car models with the latest technology features available, leasing a vehicle can be a way to do this. Leases allow you to access a new car every three years or so. In addition, because lease payments are generally less expensive than a traditional car loan, you may be able to afford a higher-end car.
The bottom line
As with many aspects of running your business, there’s no one size fits all answer to whether leasing or buying has more tax advantages. Consider how the vehicle will be used, upfront costs, long-term costs and potential added fees, along with the number of deductions you might receive before investing in a car for your business.