If you use an automobile in your trade or business, you may wonder how depreciation tax deductions are determined. The rules are complicated, and special limitations that apply to vehicles classified as passenger autos (which include many pickups and SUVs) can result in it taking longer than expected to fully depreciate a vehicle.

Cents-per-mile vs. actual expenses

First, note that separate depreciation calculations for a passenger auto only come into play if you choose to use the actual expense method to calculate deductions. If, instead, you use the standard mileage rate (56 cents per business mile driven for 2021), a depreciation allowance is built into the rate.

If you use the actual expense method to determine your allowable deductions for a passenger auto, you must make a separate depreciation calculation for each year until the vehicle is fully depreciated. According to the general rule, you calculate depreciation over a six-year span as follows: Year 1, 20% of the cost; Year 2, 32%; Year 3, 19.2%; Years 4 and 5, 11.52%; and Year 6, 5.76%. If a vehicle is used 50% or less for business purposes, you must use the straight-line method to calculate depreciation deductions instead of the percentages listed above.

For a passenger auto that costs more than the applicable amount for the year the vehicle is placed in service, you’re limited to specified annual depreciation ceilings. These are indexed for inflation and may change annually.

  • For a passenger auto placed in service in 2021 that cost more than $59,000, the Year 1 depreciation ceiling is $18,200 if you choose to deduct $8,000 of first-year bonus depreciation. The annual ceilings for later years are: Year 2, $16,400; Year 3, $9,800; and for all later years, $5,860 until the vehicle is fully depreciated.
  • For a passenger auto placed in service in 2021 that cost more than $51,000, the Year 1 depreciation ceiling is $10,200 if you don’t choose to deduct $8,000 of first-year bonus depreciation. The annual ceilings for later years are: Year 2, $16,400; Year 3, $9,800; and for all later years, $5,860 until the vehicle is fully depreciated.
  • These ceilings are proportionately reduced for any nonbusiness use. And if a vehicle is used 50% or less for business purposes, you must use the straight-line method to calculate depreciation deductions.

Heavy SUVs, pickups, and vans 

Much more favorable depreciation rules apply to heavy SUVs, pickups, and vans used over 50% for business, because they’re treated as transportation equipment for depreciation purposes. This means a vehicle with a gross vehicle weight rating (GVWR) above 6,000 pounds. Quite a few SUVs and pickups pass this test. You can usually find the GVWR on a label on the inside edge of the driver-side door.

After-tax cost is what counts

What’s the impact of these depreciation limits on your business vehicle decisions? They change the after-tax cost of passenger autos used for business. That is, the true cost of a business asset is reduced by the tax savings from related depreciation deductions. To the extent depreciation deductions are reduced, and thereby deferred to future years, the value of the related tax savings is also reduced due to time-value-of-money considerations, and the true cost of the asset is therefore that much higher.

The rules are different if you lease an expensive passenger auto used for business. Contact us if you have questions or want more information.

© 2021 Covenant CPA

Are you considering replacing a car that you’re using in your business? There are several tax implications to keep in mind.

A cap on deductions

Cars are subject to more restrictive tax depreciation rules than those that apply to other depreciable assets. Under so-called “luxury auto” rules, depreciation deductions are artificially “capped.” So is the alternative Section 179 deduction that you can claim if you elect to expense (write-off in the year placed in service) all or part of the cost of a business car under the tax provision that for some assets allows expensing instead of depreciation. For example, for most cars that are subject to the caps and that are first placed in service in calendar year 2020 (including smaller trucks or vans built on a truck chassis that are treated as cars), the maximum depreciation and/or expensing deductions are:

  • $18,100 for the first tax year in its recovery period (2020 for calendar year taxpayers);
  • $16,100 for the second tax year;
  • $9,700 for the third tax year; and
  • $5,760 for each succeeding tax year.

The effect is generally to extend the number of years it takes to fully depreciate the vehicle.

The heavy SUV strategy

Because of the restrictions for cars, you might be better off from a tax standpoint if you replace your business car with a heavy sport utility vehicle (SUV), pickup or van. That’s because the caps on annual depreciation and expensing deductions for passenger automobiles don’t apply to trucks or vans (and that includes SUVs). What type of SUVs qualify? Those that are rated at more than 6,000 pounds gross (loaded) vehicle weight.

This means that in most cases you’ll be able to write off the entire cost of a new heavy SUV used entirely for business purposes as 100% bonus depreciation in the year you place it into service. And even if you elect out of bonus depreciation for the heavy SUV (which generally would apply to the entire depreciation class the SUV belongs in), you can elect to expense under Section 179 (subject to an aggregate dollar limit for all expensed assets), the cost of an SUV up to an inflation-adjusted limit ($25,900 for an SUV placed in service in tax years beginning in 2020). You’d then depreciate the remainder of the cost under the usual rules without regard to the annual caps.

Potential caveats

The tax benefits described above are all subject to adjustment for non-business use. Also, if business use of an SUV doesn’t exceed 50% of total use, the SUV won’t be eligible for the expensing election, and would have to be depreciated on a straight-line method over a six-tax-year period.

Contact us if you’d like more information about tax breaks when you buy a heavy SUV for business. 

© 2020 Covenant CPA