Guidelines for Calculating and Deducting Depreciation As an Expense

If you use a car you own 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 depreciation deduction in the year you first place the car in service.

You generally need to know the following three things about the car you intend to depreciate.

1.      Your basis in the car.

2.      The date you place the car in service.

3.      The method of depreciation you will use.

Basis. Your basis in the car for figuring depreciation is generally its cost. This includes any amount you pay in cash, in other property, or in services. Additional rules concerning basis are discussed later in this chapter under Unadjusted basis.

Placed in service. You generally place a car 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 only for personal use and later convert it to business use, you place the car in service on the date of conversion. Your basis is the lesser of the fair market value or your adjusted basis in the car 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: the 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 of basis is in addition to those basis adjustments described later under Unadjusted basis. You must use your adjusted basis in your car to figure your depreciation deduction. For additional information on the straight line method of depreciation, see Publication 534, Depreciating Property Placed in Service Before 1987.

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.

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Percentage of business use. Generally, you must use your car more than 50% for 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, you do combine your business and investment use to compute your depreciation deduction for the 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.

1.      It is directly connected with your business.

2.      It is properly reported by you as income to the other person (and, if you have to, you withhold tax on the income).

3.      It results in a payment of fair market rent. This includes any payment to you for the use of your car.

Business use changes. If you used your car more than 50% in 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. See Business use drops to 50% or less in a later year under Car Used 50% or Less for Business, later.

More-than-50%-use test. You meet this test for any tax year if you use your car more than 50% in 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.

Property does not cease to be used more than 50% in 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.

1.      Determine the percentage of business use for the period following the change. Do this by dividing business miles by total miles driven during that period.

2.      Multiply the percentage in (1) by a fraction. The numerator (top number) is the number of months the car is used for business and the denominator (bottom number) is 12.

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).

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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 MACRS 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 your original basis in your car, which generally is 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, section 179 deduction, diesel fuel tax credit, gas guzzler tax, clean-fuel vehicle deduction, and qualified electric vehicle credit. See Publication 535 for more information on the clean-fuel vehicle deduction, and the qualified electric vehicle credit.

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.

If you acquired the car by gift or inheritance, see Publication 551, Basis of Assets, for information on your basis in the car.

Improvements. A major improvement to a car is treated as a new item of 5-year recovery property. It is treated as 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, your original basis in the new car is generally your adjusted basis in the old car plus any additional payment you make.

Traded car used only for business. If you trade in a car that you used only in your business for another car that will be used only in your business, your original basis in the new car is your adjusted basis in 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 (his $3,000 adjusted basis in 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.

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Example 2. In July 1996, 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 1996 through 1998, Marcia figured her depreciation deduction using the MACRS chart for those years.

In September 1999, 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 1999 for her old car. (See Disposition of a Car, later.)

Marcia figures her original basis in the new car, $27,792, as follows.

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 your basis in 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 your adjusted basis in the old car any additional amount you pay for the new car. Then subtract from that total the excess, if any, of:

1.      The total of the amounts that would have been allowable as depreciation during the tax years before the trade if 100% of the use of the car had been business and investment use, over

2.      The total of the amounts actually allowable as depreciation during those years.

Example 1. In March, Mark traded his 1995 van (placed in service in 1995) for a new 1999 model. He used the old van 75% for business use and he used the new van 75% for business use in 1999. Mark claimed actual expenses (including $8,494 depreciation expense) for the business use of the old van since 1995. He did not claim a section 179 deduction for the old or the new van.

Mark paid $12,800 for the 1995 van in June 1995. He paid an additional $9,800 when he acquired the 1999 van. Mark was allowed 1/2 of the depreciation deduction amount (which is included in the $8,494 depreciation expense total) for his old van for 1999, the year of disposition, as explained later under Disposition of a Car.

Mark figures the unadjusted basis for depreciating his new van as shown next.

Example 2. Rob paid $15,000 for a new car that he placed in service in 1996. He used it partly for business in 1996 (9,000 business miles of 15,000 total miles), 1997 (12,000 business miles of 16,000 total miles), and 1998 (14,400 miles of 18,000 total miles). He used the standard mileage rate in those years to claim the business use of his car. (See Depreciation adjustment when you used the standard mileage rate under Disposition of a Car, later.)

On January 2, 1999, Rob traded in this car and paid an additional $6,000 for his new car. Rob figures the unadjusted basis for his new car as shown next.

The Vehicle Mileage & Maintenance Record Book is designed for busy professionals like you who are tired of cheap tax information recording tools that fall apart and don't provide adequate room on forms for writing. Order one of our auto mileage logs today and start making this essential task simple and quick. Each book comes with a MONEY BACK GUARANTEE!  Click here to order by using our online shopping cart, downloadable order form, or through Amazon.com.