When shopping for a new car, it’s easy to get caught up in the details of deciding what make and model to buy — not to mention the color selection. But if you’re a business owner, the more important option to think through is whether to buy the car or lease it. All the standard questions to ask whether to lease or buy come into play, but there is an additional consideration — 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 on your tax returns or you can opt to use the actual expenses deduction.
- Mileage deduction: If you choose the standard mileage approach to claiming the expenses of a business vehicle on your federal tax returns, you are allowed to deduct the mileage for business miles driven, not mileage associated with any personal usage of the vehicle. Each year the IRS announces the standard mileage rate that can be used to calculate the deductible cost of operating a car for business purposes. For 2022 the rate is 58.5 cents per mile driven for business purposes.
- Lease payments: 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.
- Depreciation: 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).
- Maintenance and operating expenses: Actual expense rules also allow for the deduction of such expenses as gas, oil changes, vehicle repairs and tire purchases for your leased or purchased vehicle.
When contemplating the tax benefits of leasing a car as a business owner, it’s important to understand that those 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.
Expense differences between leased and purchased vehicles
When leasing a vehicle rather than buying one, the expenses you incur can be very different. 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.
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, such as 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 you’re 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 leases.
Is it better to lease or purchase a business vehicle?
The potential tax benefits associated with leasing a vehicle are only one of the considerations for business owners. There are many other considerations that should play a role in deciding whether it ultimately makes more sense for you and your business to buy or lease a car.
Lease contracts for instance, 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, there is a financial penalty to be paid, which can be anywhere from 10 cents to 50 cents per additional mile. If you drive a great deal for your business or drive long distances, buying a car may be a wiser move in order to eliminate worries about how many miles you’re racking up.
In addition, lease agreements often stipulate that the vehicle must 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, allowing 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 when it comes to if a lease 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 amount of deductions you might receive before investing in a car for your business.