IRS Material: Car Expense – Leased
Pub 17:
I can't see how p. 183 ff relates to car leasing. Need a more specific cite.
Recordkeeping
By keeping timely and accurate records, you will have support to show the IRS if your tax return is ever examined. Or, you will have proof of expenses that your employer may require if you are reimbursed under an accountable plan.
How To Prove Expenses
This section explains the items you need to prove depending on which expense you are deducting. It also discusses rules for the records you must keep. These rules may apply to more than one type of expense. The topics include:
Proof needed. You must be able to prove (substantiate) certain elements of expense to deduct travel, entertainment, business gift, and local transportation expenses. You cannot deduct amounts that you approximate or estimate.
Adequate records. You should keep adequate records that prove your expenses or have sufficient evidence that will support your own statement. Written evidence has considerably more value than oral evidence alone, and you must generally prepare a written record for it to be considered adequate. However, if you prepare a record in a computer memory device with the aid of a logging program, it is considered an adequate record.
You should keep the proof you need in an account book, diary, statement of expense, or similar record, and keep documentary evidence (such as receipts, canceled checks, or bills) that together will support each element of an expense. A receipt is ordinarily the best evidence to prove the amount of an expense. You cannot deduct amounts that are considered lavish or extravagant.
Confidential information. You do not need to put confidential information relating to an element of a deductible expense (such as the place, business purpose, or business relationship) in your account book, diary, or other record. However, you do have to record the information elsewhere at or near the time of the expense and have it available to fully prove that element of the expense.
Documentary evidence. You generally must have documentary evidence, such as receipts, canceled checks, or bills, to support your expenses. However, this evidence is not needed if any of the following apply:
Accountable plans and per diem allowances are discussed later under Reimbursements.
Adequate evidence. Documentary evidence ordinarily will be considered adequate if it shows the amount, date, place, and essential character of the expense.
For example, a hotel receipt is enough to support expenses for business travel if it has:
A restaurant receipt is enough to prove an expense for a business meal if it has:
If a charge is made for items other than food and beverages, the receipt must show that this is the case.
Canceled check. A canceled check, together with a bill from the payee, ordinarily establishes the cost. However, a canceled check by itself does not prove a business expense without other evidence to show that it was for a business purpose.
Proving business purpose. You must generally provide a written statement of the business purpose of an expense. However, the degree of proof varies according to the circumstances in each case. If the business purpose of an expense is clear from the surrounding circumstances, then you do not need to give a written explanation.
Duplicate information. You do not have to record information in your account book or other record that duplicates information shown on a receipt as long as your records and receipts complement each other in an orderly manner. You do not have to record amounts your employer pays directly for any ticket or other travel item. However, if you charge these items to your employer, through a credit card or otherwise, you must keep a record of the amounts you spend.
Timely recordkeeping. You do not need to write down the elements of every expense at the time of the expense. However, a record of the elements of an expense or of a business use made at or near the time of the expense or use, and supported by sufficient documentary evidence, has more value than a statement prepared later when generally there is a lack of accurate recall.
A log maintained on a weekly basis, which accounts for use during the week, is considered a timely record. An expense account statement you give your employer, client, or customer can also be considered a timely record. This is true if it is copied from your account book, diary, statement of expense, or similar record.
Separating expenses. Each separate payment usually is considered a separate expense. For example, if you entertain a customer or client at dinner and then go to the theater, the dinner expense and the cost of the theater tickets are two separate expenses. You must record them separately in your records.
Allocating total cost. If you prove the total cost of travel or entertainment but you cannot prove how much it cost for each person, you must divide the cost among you and your guests to determine the business and nonbusiness cost. To do so, divide the total cost by the total number of persons. The result is the amount you use to figure your deductible expense for each qualifying person.
Combining items. You can make one daily entry for reasonable categories of expenses such as taxi fares, telephone calls, or other incidental travel costs. Meals should be in a separate category. You can include tips with the costs of the services you received.
Expenses of a similar nature occurring during the course of a single event are considered a single expense. For example, if during entertainment at a cocktail lounge, you pay separately for each serving of refreshments, the total expense for the refreshments is treated as a single expense.
Incomplete records. If you do not have complete records to prove an element of an expense, then you must prove the element by:
If your return is examined. If your return is examined, you may have to provide additional information to the IRS. This information could be needed to clarify or to establish the accuracy or reliability of information contained in your records, statements, testimony, or documentary evidence before a deduction is allowed.
How Long To Keep Records and Receipts
You must keep proof to support your claim to a deduction as long as your income tax return can be examined. Generally, it will be necessary for you to keep your records for 3 years from the date you file the income tax return on which the deduction is claimed. A return filed early is considered filed on the due date.
Reimbursed for expenses. Employees who give their records and documentation to their employers and are reimbursed for their expenses generally do not have to keep duplicate copies of this information. However, you may have to prove your expenses if:
From Pub 463:
Car Expenses
If you use your car for business purposes, you may be able to deduct car expenses. You generally can use one of two methods to figure your expenses: actual expenses or the standard mileage rate. "Car" includes a van, pickup, or panel truck.
Standard Mileage Rate
You may be able to use the standard mileage rate to figure the deductible costs of operating your car for business purposes. You can use the standard mileage rate only for a car that you own.
For 1997, the standard mileage rate is 31.5 cents a mile for all business miles (47.25 cents a mile for U.S. Postal Service employees with rural routes). These rates are adjusted periodically for inflation.
Caution. If you choose to use the standard mileage rate, you cannot deduct your actual car expenses. These include depreciation, maintenance and repairs, gasoline (including gasoline taxes), oil, insurance, and vehicle registration fees.
You generally can use the standard mileage rate whether or not you are reimbursed and whether or not any reimbursement is more or less than the amount figured using the standard mileage rate.
Choosing the standard mileage rate. If you want to use the standard mileage rate for a car, you must choose to use it in the first year the car is available for use in your business. Then in later years, you can choose to use the standard mileage rate or actual expenses.
If you choose to use the standard mileage rate, you are considered to have chosen not to use the depreciation methods discussed later. This is because the standard mileage rate includes an allowance for depreciation. You also cannot claim the Section 179 deduction (discussed later) if you use the standard mileage rate. If you change to the actual expenses method in a later year, but before your car is considered fully depreciated, you have to estimate the remaining useful life of the car and use straight line depreciation. See the exception in Methods of depreciation under Depreciation Deduction, later.
Standard mileage rate not allowed. You cannot use the standard mileage rate if you:
Two or more cars. If you own two or more cars that are used for business at the same time, you cannot use the standard mileage rate for the business use of any car. However, you may be able to deduct a part of the actual expenses for operating each of the cars. See Actual Car Expenses for information on how to figure your deduction.
You are not using two or more cars for business at the same time if you alternate using (use at different times) the cars for business.
The following examples illustrate the rules for when you can and cannot use the standard mileage rate for two or more cars.
Example 1. Marcia, a salesperson, owns a car and a van that she alternates using for calling on her customers. She can use the standard mileage rate for the business mileage of the car and the van.
Example 2. Tony uses his own pickup truck in his landscaping business. During the year, he traded in his old truck for a newer one. Tony can use the standard mileage rate for the business mileage of both the old and the new trucks.
Example 3. Chris owns a repair shop and an insurance business. He uses his pickup truck for the repair shop and his car for the insurance business. No one else uses either the pickup truck or the car for business purposes. Chris can use the standard mileage rate for the business use of the truck and the car.
Example 4. Maureen owns a car and a van that are both used in her housecleaning business. Her employees use the car and she uses the van to travel to the various customers. Maureen cannot use the standard mileage rate for the car or the van. This is because both vehicles are used in Maureen's business at the same time. She must use actual expenses for both vehicles.
Interest. If you are an employee, you cannot deduct any interest paid on a car loan. This applies even if you use the car 100% for business as an employee.
However, if you are self-employed and use your car in your business, you can deduct that part of the interest expense that represents your business use of the car. For example, if you use your car 50% for business, you can deduct 50% of the interest on Schedule C (Form 1040). You cannot deduct the rest of the interest expense.
Personal property taxes. If you itemize your deductions on Schedule A (Form 1040), you can deduct on line 7 state and local personal property taxes on motor vehicles. You can take this deduction even if you use the standard mileage rate or if you do not use the car for business.
If you are self-employed and use your car in your business, you can deduct the business part of state and local personal property taxes on motor vehicles on Schedule C, Schedule C-EZ, or Schedule F (Form 1040).
Parking fees and tolls. In addition to using the standard mileage rate, you can deduct any business-related parking fees and tolls. (Parking fees that you pay to park your car at your place of work are nondeductible commuting expenses.)
Sale, trade-in, or other disposition. If you sell, trade in, or otherwise dispose of your car, you may have a gain or loss on the transaction or an adjustment to the basis of your new car. See Disposition of a Car, later.
Actual Car Expenses
If you do not choose to use the standard mileage rate, you may be able to deduct your actual car expenses.
Tax Tip. If you qualify to use both methods, figure your deduction both ways to see which gives you a larger deduction.
Actual car expenses include the costs of:
If you have fully depreciated a car that you are still using in your business, you can continue to claim your other actual expenses for the business use of your car. Continue to keep records.
Business and personal use. If you use your car for both business and personal purposes, you must divide your expenses between business and personal use.
Example. You are a sales representative for a clothing firm and drive your car 20,000 miles during the year: 12,000 miles for business and 8,000 miles for personal use. You can claim only 60% (12,000 ≈ 20,000) of the cost of operating your car as a business expense.
Employer-provided vehicle. If you use a vehicle provided by your employer for business purposes, you can deduct your actual unreimbursed car expenses. You cannot use the standard mileage rate if you do not own the car.
Interest on car loans. If you are an employee, you cannot deduct any interest paid on a car loan. This interest is treated as personal interest and is not deductible. If you are self-employed and use your car in that business, However, if you are self-employed and use your car in your business, you can deduct that part of the interest expense that represents your business use of the car.
Taxes paid on your car. If you are an employee, you can deduct personal property taxes paid on your car if you itemize deductions. Enter the amount paid on line 7 of Schedule A (Form 1040).
You cannot deduct luxury or sales taxes, even if you use your car 100% for business. Luxury and sales taxes are part of your car's basis and may be recovered through depreciation. See Depreciation Deduction, later.
Fines and collateral. Fines and collateral for traffic violations are not deductible.
Casualty and theft losses. If your car is damaged, destroyed, or stolen, you may be able to deduct part of the loss that is not covered by insurance, whether or not you used your car entirely for business.
Depreciation. Generally, the cost of a car, plus sales tax, luxury tax, and improvements, is a capital expense. Because the benefits last longer than one year, you generally cannot deduct a capital expense. However, you can recover this cost by claiming a Section 179 deduction (the deduction allowed by Section 179 of the Internal Revenue Code) and/or a depreciation deduction. In other words, you recover the cost over more than one year by deducting part of it each year. The Section 179 deduction and the depreciation deduction are discussed later.
Generally, there are limits on both of these deductions, and special rules apply if you use your car 50% or less in your work or business.
You can claim a Section 179 deduction and a depreciation method other than straight line only if you do not use the standard mileage rate to figure your business-related car expenses in the year you first place a car in service. If you claim either a depreciation deduction or a Section 179 deduction in the year you first place a car in service, you cannot use the standard mileage rate on that car in any future year.
Car defined. For depreciation purposes, a car is any four-wheeled vehicle that is made primarily for use on public streets, roads, and highways. It must have an unloaded gross vehicle weight of 6,000 pounds or less. A truck or van is included in the definition only if it has a gross vehicle weight of 6,000 pounds or less. A car includes any part, component, or other item that is physically attached to it or is traditionally included in the purchase price.
A car does not include:
Section 179 Deduction
The Section 179 deduction allows you to choose to treat part or all of the business cost of a car as an expense rather than taking depreciation deductions over a specified recovery period. As an expense, the Section 179 amount is deductible only in the year the car is placed in service. For this purpose, placed in service means the year you first use the car for any purpose. A car first used for personal purposes cannot qualify for the deduction in a later year when its use changes to business.
Example. In 1995 you bought a new car and placed it in service for personal purposes. In 1997 you began to use it for business. The fact that you changed its use to business use does not qualify the cost of your car for a Section 179 deduction in 1997. However, you can claim a depreciation deduction for the business use of the car in 1997. See Depreciation Deduction, later.
Limits. There are limits on:
Limit on cost of qualifying property. Generally, you can choose to treat up to $18,000 of the cost of qualifying property as a Section 179 deduction in 1997. The yearly limit, however, depends on the percentage of business use, and you must use the property more than 50% for business to claim any Section 179 deduction.
Tax Tip. The limit on the cost of property qualifying for the Section 179 deduction increases each year up to 2003. However, the maximum limits for the business cost of a car, discussed later, continue to apply.
Example. Peter purchased a car this year for $4,500 and he used it 60% for business. The total cost of Peter's car that qualifies for the Section 179 deduction is $2,700 ($4,500 cost ╫ 60% business use). But see Limit on total Section 179 and depreciation deductions, discussed next.
Limit on total Section 179 and depreciation deductions. The total amount of Section 179 and depreciation deductions that you can claim for a car that you place in service in 1997 cannot be more than $3,160. The limit is reduced if your business use of the car is less than 100%. See Depreciation Limits, later, for more information.
Example. Peter, in the previous example, had a car with a qualifying cost of $2,700 for his Section 179 deduction. However, Peter is limited to a total Section 179 deduction plus depreciation deduction of $1,896 ($3,160 limit ╫ 60% business use).
Cost of car. The business cost of the car for purposes of the Section 179 deduction does not include any amount figured by reference to any other property held by you at any time. For example, if you trade in a used car on a new car to use in your business, your cost for purposes of the Section 179 deduction does not include the adjusted basis of the car you trade in for the new car.
Basis of car. The amount of the Section 179 deduction reduces the basis of your car. If you choose the Section 179 deduction, you must reduce the basis of your car before you figure your depreciation deduction.
Generally, choosing a Section 179 deduction gives you a larger total deduction (depreciation plus Section 179 deduction) in the first year. Not choosing it gives you a larger depreciation deduction in the later years.
Example. On January 3, 1997, Stella bought a car for $12,000, including sales tax, to use exclusively in her delivery business. She paid $9,000 cash and received $3,000 in trade for her old car (also used in her business). The adjusted basis of her old car was $3,000.
Stella's cost of the new car is $9,000 for purposes of Section 179. Her basis for depreciation would be $12,000 if she does not choose Section 179. The total of her Section 179 and depreciation deductions is limited to $3,160, the first year maximum. If she does not choose Section 179, her depreciation deduction, using the MACRS method (discussed later), would be $2,400 [$12,000 basis ╫ 20% (double declining balance rate)].
When to choose. If you want to take the Section 179 deduction, you must make the choice in the tax year you both purchase the car and place it in service for business or work. Employees use Form 2106 to make this choice and report the Section 179 deduction. All others use Form 4562. Make your choice by taking the deduction on the appropriate form and file it with your original tax return. You cannot make the choice on an amended tax return filed after the due date (including extensions). Once made, the choice can be changed only with the consent of the Internal Revenue Service.
Reduction in business use. To be eligible to claim the Section 179 deduction, you must use your car more than 50% for business or work in the year you acquired it. If your business use of the car is 50% or less in a later tax year during the recovery period, you have to include in income in that later year any excess depreciation. Any Section 179 deduction claimed on the car is included in calculating the excess depreciation.
Dispositions. If you dispose of a car on which you had claimed the Section 179 deduction, the amount of that deduction is treated as a depreciation deduction for recapture purposes. Any gain on the disposition of the property is treated as ordinary income up to the amount of the Section 179 deduction and any depreciation you claimed.
Depreciation Deduction
If you use a car in your business, you can claim a depreciation deduction: that is, you can deduct a certain amount each year as a recovery of your cost or other basis in the car. You cannot use the standard mileage rate if you decide to take a deprecation deduction in the year you first place the car in service.
You generally need to know three things about the car you intend to depreciate. You must know:
Basis. The car's basis for figuring depreciation is your original basis reduced by:
The original basis of property you buy is usually its cost. Additional rules concerning basis are discussed under Unadjusted Basis.
Placed in service. A car generally is placed in service when it is available for use in your work or business, in the production of income, or in a personal activity. Depreciation begins when the car is ready for use in your work or business or for the production of income.
For purposes of computing depreciation, if you first start using the car entirely for personal use and later convert it to business use, the car is treated as placed in service on the date of conversion. Your basis is the lesser of the fair market value or the car's adjusted basis on the date of conversion.
Car placed in service and disposed of in the same year. If you place a car in service and dispose of it in the same tax year, you cannot claim any depreciation deduction for that car.
Methods of depreciation. Generally, one depreciation system is available for cars: modified accelerated cost recovery system (MACRS). MACRS rules for cars are discussed later in this chapter.
Exception. If you used the standard mileage rate in the first year of business use and change to the actual expenses method in a later year, you cannot depreciate your car under the MACRS rules. You must use straight line depreciation over the estimated remaining useful life of the car.
To figure depreciation under the straight line method, you must reduce your basis in the car (but not below zero) by a set rate per mile for all miles for which you used the standard mileage rate. The rate per mile varies depending on the year(s) you used the standard mileage rate. For the rate(s) to use, see Depreciation adjustment when you used the standard mileage rate under Disposition of a Car, later.
This reduction to basis is in addition to those basis adjustments described later under Unadjusted Basis. You must use the adjusted basis of your car to figure your depreciation deduction.
Cars placed in service before 1987. If you are still depreciating a car you placed in service before 1987, continue to follow the rules appropriate for that method. See Publication 534 for more information.
Percentage of business use. Generally, you must use a car more than 50% for a qualified business use (defined next) to qualify for the Section 179 deduction and MACRS deduction. If your business use is 50% or less, you must use the straight line method to depreciate your car. This is explained later under Car Used 50% or Less for Business.
Qualified business use. A qualified business use is any use in your trade or business. It does not include use for the production of income (investment use). However, after you have satisfied the 50%-business-use requirement, you may combine your business and investment use to compute any allowable deduction for a tax year.
Use of your car by another person. Do not treat any use of your car by another person as use in your trade or business unless that use meets one of the following three conditions.
Business use changes. If you used your car more than 50% in a qualified business use in the year you placed it in service, but 50% or less in a later year (including the year of disposition), you have to change to the straight line method of depreciation.
More-than-50%-use test. You meet this test for any tax year if you use your car more than 50% in a qualified business use. You must meet this test each year of the recovery period (6 years under MACRS) for your car.
If you use your car for more than one purpose during the tax year, you must allocate the use to the various purposes. You do this on the basis of mileage. Figure the percentage of qualified business use by dividing the number of miles you drive your car for business purposes during the year by the total number of miles you drive the car during the year for any purpose.
Tax Tip. Property does not cease to be used more than 50% in a qualified business use by reason of a transfer at death.
Change from personal to business use. If you change the use of a car from 100% personal use to business use during the tax year, you may not have mileage records for the time before the change to business use. In this case, you figure the percentage of business use for the year as follows.
Example. You use a car only for personal purposes during the first 6 months of the year. During the last 6 months of the year, you drive the car a total of 15,000 miles of which 12,000 miles are for business. This gives you a business use percentage of 80% (12,000 ≈ 15,000) for that period. Your business use for the year is 40% (80% ╫ 6/12).
Limits. The amount you can claim for Section 179 and depreciation deductions may be limited. Maximum limits apply depending on the year in which you placed your car in service. You have to adjust the limits if you did not use the car exclusively for business. See Depreciation Limits, later.
Unadjusted basis. You use your unadjusted basis to figure your depreciation using the depreciation chart explained later under Modified Accelerated Cost Recovery System (MACRS). Your unadjusted basis for figuring depreciation is your original basis increased or decreased by certain amounts.
To figure your unadjusted basis, begin with the original basis of your car, generally its cost. Cost includes sales and luxury taxes, destination charges, and dealer preparation. Increase your basis by any substantial improvements you make to your car, such as adding air conditioning or a new engine. Decrease your basis by any deductible casualty loss, diesel fuel tax credit, gas guzzler tax, clean-fuel vehicle deduction, and qualified electric vehicle credit.
If you use your car exclusively for business, subtract the Section 179 deduction from the result to arrive at your unadjusted basis. If you use your car only partly for business, multiply the result by the business use percentage and then subtract the Section 179 deduction to arrive at your unadjusted basis.
Caution. If your business use later falls to 50% or less, you may have to include in your income any excess depreciation. See Car Used 50% or Less for Business, later, for more information.
Improvements. A major improvement to a car is treated as a new item of 5-year recovery property that is placed in service in the year the improvement is made. It does not matter how old the car is when the improvement is added. Follow the same steps for depreciating the improvement as you would for depreciating the original cost of the car. However, you must treat the improvement and the car as a whole when applying the limits on the depreciation deductions. Your car's depreciation deduction for the year (plus the depreciation on any improvements) cannot be more than the depreciation limit that applies for that year. See Depreciation Limits, later.
Effect of trade-in on basis. When you trade an old car for a new one, the original basis of the new car is generally the adjusted basis of the old car plus any additional payment you make.
Traded car used entirely for business. If you trade in a car that you used entirely in your business for another car that will be used entirely in your business, the original basis of the new car is the adjusted basis of the old car, plus any additional amount you pay for the new car.
Example 1. Paul trades in a car that has an adjusted basis of $3,000 for a new car. In addition, he pays cash of $7,000 for the new car. His original basis of the new car is $10,000 (the $3,000 adjusted basis of the old car plus the $7,000 cash paid). Paul's unadjusted basis would be the same unless he claims the Section 179 deduction or has other increases or decreases to his original basis.
Example 2. In July 1994, Marcia purchased a car for $26,000 and placed it in service for 100% use in her business. She did not claim a Section 179 deduction. Marcia's unadjusted basis for the car was $26,000. For 1994 through 1996, Marcia figured her depreciation deduction using the MACRS chart for those years.
In September 1997, Marcia traded that car in and paid $14,200 cash for a new car to be used 100% in her business. Marcia is allowed one-half of the regular depreciation amount for 1997 for her old car. (See Disposition of a Car, later.)
Marcia figures her original basis in the new car, $28,192, as follows.
Cost of old car: $26,000
Less: Total depreciation allowed,1994 through '97 - 12,008
Adjusted basis of old car $13,992
Plus: Additional cost for new car 14,200
Basis of new car $28,192
Traded car used partly in business. If you trade in a car (that you acquired after June 18, 1984) that you used partly in your business for a new car that you will use in your business, you must make a "trade-in" adjustment for the personal use of the old car. This adjustment has the effect of reducing the basis of your old car, but not below zero, for purposes of figuring your depreciation deduction for the new car. (This adjustment is not used, however, when you determine the gain or loss on the later disposition of the new car.)
To figure the unadjusted basis of your new car for depreciation, first add to the adjusted basis of the old car any additional amount you pay for the new car. Then subtract from that total the excess, if any, of:
Modified accelerated cost recovery system (MACRS). The modified accelerated cost recovery system (MACRS) is the name given to the tax rules for getting back (recovering) through depreciation deductions the cost of property used in a trade or business or to produce income.
The maximum amount you can deduct is limited, depending on the year you placed your car in service. See Depreciation Limits, later.
Recovery period. Under MACRS, cars are classified as 5-year property. You actually depreciate the cost of a business car, truck, or van over a period of 6 calendar years. This is because your car is generally treated as placed in service or disposed of in the middle of the year.
Depreciation deduction for certain Indian reservation property. Shorter recovery periods are provided under MACRS for qualified Indian reservation property placed in service on Indian reservations after 1993 and before 2004. The recovery period that applies for a business-use car is 3 years instead of 5 years. However, the depreciation limits, discussed later, will still apply.
Depreciation methods. There are three methods that you can use to depreciate your car:
Tax Tip. If you use Table 3 (discussed later) to determine your depreciation rate for 1997, you do not need to determine in what year your deduction is greater using the straight line method. This is because the chart has the switch to the straight line method built into its rates.
Before choosing a method, you may wish to consider the following:
MACRS depreciation chart. A 1997 MACRS Depreciation Chart and instructions are included in this section as Table 3. Using this table will make it easy for you to figure the 1997 depreciation deduction for your car. A similar chart appears in the Instructions for Form 2106.
Caution. You may have to use the tables in Publication 946 instead of using this MACRS Depreciation Chart.
You must use the Depreciation Tables in Publication 946, and not use the MACRS depreciation chart in this publication, if any of the following conditions apply to you.
If you use the percentages from the chart, you must continue to use them for the entire recovery period of your car. However, you cannot continue to use the chart if the basis of your car is adjusted because of a casualty. In that case, for the year of adjustment and the remaining recovery period, figure the depreciation without the chart using the car's adjusted basis at the end of the year of adjustment and over the remaining recovery period.
Tax Tip. In future years, do not use the chart from this publication. Instead, use the chart in the publication or in the instructions for those future years.
If you dispose of the car before the end of the recovery period, you are generally allowed a half year of depreciation in the year of disposition unless you purchased the car during the last quarter of a year.
How to use the 1997 chart. To figure your depreciation deduction for 1997, find the percentage in the column of the chart based on the date that you first placed the car in service and the depreciation method that you are using. Multiply the unadjusted basis of your car (defined earlier) by that percentage to determine the amount of your depreciation deduction. If you prefer to figure your depreciation deduction without the help of the chart, see Publication 946.
Your deduction cannot be more than the maximum depreciation limit for cars. See Depreciation Limits, later.
Example. Phil bought a used truck in February 1996 to use exclusively in his landscape business. He paid $6,200 for the truck with no trade-in. Phil did not claim any Section 179 deduction and he chose to use the 200% DB method to get the largest depreciation deduction in the early years.
Phil used the MACRS depreciation chart in 1996 to find his percentage. The unadjusted basis of his truck equals its cost because Phil used it exclusively for business. He multiplied the unadjusted basis of his truck, $6,200, by the percentage that applied, 20%, to figure his 1996 depreciation deduction of $1,240.
In 1997, Phil used the truck for personal purposes when he repaired his father's cabin. His records show that the business use of his truck was 90% in 1997. Phil used Table 3 to find his percentage. Reading down the first column for the date placed in service and across to the 200% DB column, he locates his percentage, 32%. He multiplies the unadjusted basis of his truck, $5,580 ($6,200 cost ╫ 90% business use), by 32% to figure his 1997 depreciation deduction of $1,786.
Depreciation Limits
There are limits on the amount you can deduct for depreciation of your car. (The Section 179 deduction is treated as depreciation for purposes of the limits.) The maximum amount you can deduct each year depends on the year you place the car in service. These limits are shown in the following table.
Maximum Depreciation Limits
Yr placed in service 1st yr 2nd yr 3rd yr 4th & later yrs
1997 $3,160 $5,000 $3,050 $1,775
95-96 3,060 4,900 2,950 1,775
94 2,960 4,700 2,850 1,675
93 2,860 2,860 2,750 1,675
92 2,760 2,760 4,400 1,575
91 2,660 4,300 2,550 1,575
pre-91 1,475
Exceptions for clean-fuel cars. There are two exceptions to the depreciation limits. They are effective after August 5, 1997, for cars that run on clean fuel:
Car used less than full year. The depreciation limits are not reduced if you use a car for less than a full year. This means that you do not reduce the limit when you either place a car in service or dispose of a car during the year. However, the depreciation limits are reduced if you do not use the car exclusively for business and investment purposes. See Reduction for personal use, later.
Example. Marie purchased a car in June 1997 for $16,000 to use exclusively in her business. She does not claim the Section 179 deduction and she chooses the 200% DB method of depreciation.
Marie's depreciation (using the rate from Table 3) is $3,200 ($16,000 ╫ 20%). However, the maximum amount she can deduct for depreciation (from the Maximum Depreciation Limits table) is $3,160. (See Deductions in Years After the Recovery Period, later.)
Reduction for personal use. The depreciation limits are further reduced based on your percentage of personal use. If you use a car less than 100% in your business or work, you must determine the depreciation deduction limit by multiplying the limit amount by the percentage of business and investment use during the tax year.
Example. In June 1997, Karl, an outside dental supply salesman, purchased a car for $25,400 to make sales calls in a territory that extends 200 miles around his home base. He uses his car 85% for his business. Karl does not claim the Section 179 deduction and he chooses the 200% DB method to figure his depreciation deduction.
In 1997, Karl computes his MACRS deduction to be $4,318 [($25,400 ╫ 85%) ╫ 20%]. However, Karl's deduction is limited to $2,686. This is the depreciation limit ($3,160) multiplied by the business use percentage (85%).
Karl continues to use his car 85% for business. Depreciation in the next four years continues to be subject to deduction limits. Karl computes his depreciation limits for those years as follows:
In 2002, Karl's MACRS deduction is $1,244 [($25,400 ╫ 85%) ╫ 5.76%]. Since that amount is less than the depreciation limit of $1,509 ($1,775 ╫ 85%), Karl's depreciation deduction for 2002 is $1,244.
If Karl continues to use his car for business after 2002, he can continue to claim a depreciation deduction for his unrecovered basis. However, he cannot deduct more than $1,775 multiplied by his business use percentage. See Deductions in years after the recovery period, later.
Section 179 deduction. The Section 179 deduction is treated as a depreciation deduction. If you place a car in service in 1997, use it only for business, and choose the Section 179 deduction, the combined Section 179 and depreciation deduction for that car for 1997 is limited to $3,160.
Example. On September 5, 1997, Jack bought a used car for $6,000 and placed it in service. He used it 80% for his business and he chooses to take a Section 179 deduction for the car.
Before applying the limit, Jack figures his maximum Section 179 deduction to be $4,800. This is the amount of his qualifying property (up to the maximum $18,000 amount) multiplied by his business use ($6,000 ╫ 80%).
Jack then figures that his Section 179 deduction for 1997 is limited to $2,528 (80% of $3,160). He then has an unadjusted basis of $2,272 [($6,000 ╫ 80%) - $2,528] for determining his depreciation deduction. Since he has already reached the maximum limit for 1997, Jack will use the unadjusted basis to figure his depreciation deduction for 1998.
Deductions in years after the recovery period. If the depreciation limits apply to your car, you may have unrecovered basis in your car at the end of the recovery period. You can deduct that unrecovered basis after the recovery period ends.
Unrecovered basis. This is the cost or other basis of the car reduced by any clean-fuel vehicle deduction, electric vehicle credit, and depreciation and Section 179 deductions that would have been allowable if you had used the car 100% for business and investment use.
How to treat unrecovered basis. If you continue to use your car for business after the recovery period, you can claim a depreciation deduction for each succeeding tax year until you recover your full basis in the car. The maximum amount you can deduct is determined by the date you placed the car in service.
The recovery period. For cars placed in service after 1986, your recovery period is 6 calendar years. For a 5-year recovery period, a part year's depreciation is allowed in the first calendar year, a full year's depreciation is allowed in each of the next 4 calendar years, and the rest of the first year's depreciation is allowed in the 6th calendar year.
Your recovery period is the same whether you use MACRS declining balance or straight line depreciation. Under MACRS, you determine your unrecovered basis in the 7th year after the car was placed in service.
Deduction amount after the recovery period. In years after the recovery period, a deduction for the unrecovered basis is allowed only for the business use of the car. If you use your car less than 100% for business, the depreciation deduction will be less than the maximum amount. For example, no deduction is allowed for a year you use your car 100% for personal purposes.
Car Used 50% or Less for Business
If you use your car 50% or less in a qualified business use (defined earlier under Depreciation Deduction), special rules apply. For this purpose, "car" was defined earlier under Actual Car Expenses. When figuring your depreciation deduction:
Instead of making the computation yourself, you can use used the MACRS Depreciation Chart and Maximum Limits Table to find the percentage to use.
Example. On May 21, 1997, Dan bought a car for $15,000. He used it 40% for his consulting business. Because he did not use the car more than 50% for business, Dan cannot take any Section 179 deduction, and he must use the straight line method over a 5-year period to recover the cost of his car.
Dan deducts $600 in 1997. This is the lesser of:
Business use drops to 50% or less in a later year. If you use your car more than 50% in a qualified business use in the tax year it is placed in service but not in a later tax year, special rules apply to the years during the recovery period (6 years). For the year your business use drops to 50% or less and all later years, you must do the following:
Example. In June 1994, you purchased a car for exclusive use in your business. You met the more-than-50%-use test for the first 3 years of the recovery period (1994 through 1996) but failed to meet it in the fourth year (1997). You determine your depreciation for 1997 using 20% (from the MACRS Depreciation Chart and Maximum Limits Table). You also will have to determine and include in your gross income any excess depreciation, discussed next.
Excess depreciation. You must include any excess depreciation in your gross income and add it to your car's adjusted basis for the first tax year in which the car is not used more than 50% in a qualified business use. Use Form 4797, Sales of Business Property, to report the excess depreciation in your gross income.
Excess depreciation is:
Example. On June 25, 1994, you bought a car for $11,000 and placed it in service. You did not claim the Section 179 deduction. You used the car exclusively in a qualified business use for 1994, 1995, and 1996. For those years, you used the MACRS chart to figure depreciation deductions totaling $7,832 ($2,200 for 1994, $3,520 for 1995, and $2,112 for 1996).
During 1997, you used the car 50% for business and 50% for personal purposes. Since you did not meet the more-than-50%-use test, you must include in gross income for 1997 your excess depreciation determined as follows:
Total depreciation claimed: $7,832
(MACRS 200% DB method)
Total depreciation allowable:
(Straight line method)
1994--10% of $11,000..............$1,100
1995--20% of $11,000...............2,200
1996--20% of $11,000...............2,200 5,500
------------------------------------------------------------------
Excess depreciation $2,332
In 1997, you must include $2,332 in your gross income using Form 4797. Your adjusted basis for the car is also increased by $2,332. Your 1997 depreciation deduction is $1,100 [$11,000 (unadjusted basis) ╫ 50% (business use percentage) ╫ 20% (from the MACRS Depreciation Chart and Maximum Limits Table).
Disposition of a Car
If 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 or clean-fuel vehicle deduction) that you claimed on the car will be treated as ordinary income. However, you may not have to recognize a gain or loss if you dispose of the car because of a casualty, theft, or trade-in.
Casualty or theft. For a casualty or theft, a gain results when you receive insurance or other reimbursement that is more than the adjusted basis of your car. If you then spend all of the proceeds to acquire replacement property (a new car or repairs to the old car) within a specified period of time, you do not recognize any gain. The basis of the replacement property is its cost minus any gain that is not recognized.
Trade-in. When you trade in an old car for a new one, the transaction is considered a like-kind exchange. Generally, no gain or loss is recognized. In a trade-in situation, the basis of the new property is generally the adjusted basis of the old property plus any additional amount you pay. (See Unadjusted Basis, earlier.)
Depreciation adjustment when you used the standard mileage rate. If you used the standard mileage rate for the business use of your car, depreciation was included in that rate. The rate of depreciation that was allowed in the standard mileage rate is shown in the chart that follows. This depreciation reduces the basis of your car (but not below zero) in figuring its adjusted basis when you dispose of it.
Tax Tip. These rates do not apply for any year in which the actual expenses method was used.
Depreciation
Year(s) Rate per Mile
------------------------------------------------------------------------
1994 - 1997 .12
1992 - 1993 .11 1/2
1989 - 1991 .11
1988 .10 1/2
1987 .10
1986 .09
1983-85 .08
1982 .07 1/2
1980-81 .07
For tax years before 1990, the depreciation rates apply to the first 15,000 miles. For tax years after 1989, the depreciation rates apply to all business miles.
Depreciation deduction for the year of disposition. If you deduct actual car expenses and you dispose of your car before the end of its recovery period, you are allowed a reduced depreciation deduction for the year of disposition.
To figure the reduced depreciation deduction for a car disposed of in 1997, first determine the depreciation deduction for the full year using the MACRS Depreciation Chart and Maximum Limits Table.
If you used a Date Placed in Service line for Jan. 1--Sept. 30, you can deduct half the regular depreciation amount for the year of disposition. Figure your depreciation deduction for the full year using the rules explained in this chapter and deduct 50% of that amount with your other actual car expenses.
If you used a Date Placed in Service line for Oct. 1--Dec. 31, you can deduct a percentage of the regular depreciation amount that is based on the month you disposed of the car. Figure your depreciation deduction for the full year using the rules explained in this chapter and multiply the result by the percentage from the following table for the month that you disposed of the car.
Month Percentage
Jan., Feb., March 12.5%
April, May, June 37.5%
July, Aug., Sept. 62.5%
Oct., Nov., Dec. 87.5%
Caution. Do not use this table if you are a fiscal year filer. See Dispositions in chapter 3 of Publication 946.
Leasing a Car
If you lease a car that you use in your business, you can deduct the part of each lease payment that is for the use of the car in your business. You cannot deduct any part of a lease payment that is for commuting to your regular job or for any other personal use of the car.
You must spread any advance payments over the entire lease period. You cannot deduct any payments you make to buy a car even if the payments are called lease payments.
If you lease a car that you use in your business for 30 days or more, you may have to include an "inclusion amount" in your income for each tax year you lease the car. The inclusion amount has the effect of reducing your deduction for your lease payment. For information on reporting inclusion amounts, see Car rentals under Completing Forms 2106 and 2106-EZ in chapter 6 if you are an employee. See the instructions for Schedule C (Form 1040) if you are a sole proprietor and Schedule F (Form 1040) if you are a farmer.
The inclusion amount is a percentage of part of the fair market value of the leased car multiplied by the percentage of business and investment use of the car for the tax year. The inclusion amount is prorated for the number of days of the lease term included in the tax year. The effect of adding this amount to income is to limit your deduction for lease payments so that it equals the depreciation deduction you would have on the car if you owned it.
Inclusion Amounts
If you lease a car for a lease term of 30 days or more, you may have to include an inclusion amount in your gross income. This applies to each tax year that you lease the car if the fair market value (defined next) of the car when the lease began was more than:
Fair market value is the price at which the property would change hands between a buyer and a seller, neither having to buy or sell, and both having reasonable knowledge of all the necessary facts. Sales of similar property around the same date may be helpful in figuring the fair market value of the property.
The fair market value is the value on the first day of the lease term. If the capitalized cost of a car is specified in the lease agreement, that amount is treated as the fair market value.
Figuring the inclusion amount. Use the table in the appropriate Appendix B (depending on the year you first placed the car in service), included at the end of this publication, to determine the inclusion amount if the fair market value of the car is $100,000 or less. (See the Revenue Procedures identified in the second footnote of the Appendices for the inclusion amount if the fair market value is more than $100,000. They are available at most IRS offices and many local libraries.) For each tax year during which you lease the car, the inclusion amount is determined as follows:
To determine the dollar amount from the table in the appropriate Appendix B, use the fair market value of the car on the first day of the lease term to find the correct line of the table. Use the tax year in which the car is used under the lease to find the correct column of the table. However, for the last tax year of the lease, use the dollar amount for the preceding year.
Leased car changed from business to personal use. If you first lease a car for business use and, in a later year, change it to personal use, follow the rules explained earlier under Figuring the inclusion amount. Since this is the last year of the business use of the leased car, use the amount for the preceding year of the lease, and prorate the amount for the number of days in the lease term included in the tax year.
Leased car changed from personal to business use. If you first lease a car for personal use and, in a later year, change it to business use, you must determine the car's fair market value on the date of conversion. Then follow the rules explained earlier under Figuring the inclusion amount. Use the fair market value on the date of conversion, and the appropriate Appendix B for the year of conversion.