Hans Kasper, MS-CPA, PS

Auto Lease vs. Purchase on a Business Vehicle
 

When you enter an auto dealership, one of the questions that you have to resolve is: Should I lease or buy?  The salesperson will tell you that if you are using the vehicle for business that the tax write off is better with a lease.  What is the best answer?

My personal preference is to buy the car or truck.  I am the type of person who buys a car and keeps it for more than ten years.  Some clients say that they have to have a new car every three years, so they take a lease.  These are personal preferences, but, tax wise, what makes more cents?

There are many leases that have mileage caps.  If you turn in the car at the end of a three year lease with more than 45,000 mile on it, then you are going to have to pay $X.XX per mile of the excess.

Another question that needs to be asked is: What is better--actual expenses (lease or buy) or mileage?

Let's see if we can answer these questions.

First, let's make a list of actual vehicle operating expenses. In the following information, the terms auto, car, vehicle, and truck are used interchangeably.  The operating expenses are:

• annual lease cost (less the inclusion amount = 75% of one month's payment--this is done to make the lease similar to depreciating and financing the car) or depreciation on a purchased vehicle,

• auto license,

• gas and oil changes,

• insurance,

• interest expense on a purchased car,

• repairs,

• tires including winter tires, and

• new sound system, battery charger, etc.

Parking fees and tolls are 100% deductible whether you lease or buy.

Here are some other issues that you need to know about.

• Once actual expenses have been elected to be used on a vehicle, you can not switch back to the standard mileage rate.

• If you use the standard mileage rate in the first year of use, then you can switch between actual expenses and mileage in later years based on whichever one is better for you.

• Once you use the standard mileage rate for a leased vehicle, then you must use it for the entire lease period.

• You can use the standard mileage rate for up to four vehicles at the same time for business purposes, then you must use actual expenses.  You are not using two or more vehicles for business if you alternate usage between the cars.

• When you use the standard mileage rate, the depreciation component is 16 cents per mile.  Therefore, when you sell the vehicle, you may have a gain or loss on the vehicle.

• If you are an employee and use the standard mileage rate, you can not deduct the interest expense on a purchased car.  If you are self-employed and use the standard mileage rate, you can also deduct the interest expense on a purchased car.

• It seems obvious, if you are self-employed, that when using business mileage to take your auto deduction (you are generally driving more than 15,000 to 20,000 miles per year), that it is better to buy the car than lease it.  When you buy the car, interest expense is deductible in addition to mileage, and when you lease it, you only get the mileage.

• To be able to elect Section 179 depreciation on a vehicle, you must use it for business more than 50%.  If the usage later drops to less than 50%, then you must recapture (pay tax on) some or all of the section 179 depreciation.

• Section 179 (25,000 in 2006) can be taken on large vehicles--SUVs and large trucks over 6,000 lbs.

• YOU MUST keep track of the business mileage and the beginning of and end of the year mileage readings. 

• SAMPLING: Business miles can be tracked daily or by using a technique called "sampling" that is allowed under Reg.1.274-5T(c)(3)(ii).  With sampling, you are treated as having adequate substantiation if you keep records for a portion of the year that is representation of use for the entire year.  For example: you would keep records for the first three months of the each year, determine your business percentage, and use that percentage for the remainder of the year.

• TIP: You may wish to use your business schedule and Map Quest on the internet to determine business miles.  But, please note that the tax court rejected this method since the person failed to keep the odometer reading for each trip. (Olsen TC Memo 2002-42, affirmed CA-9 2003) 

• The actual expenses for business purposes are determine by the percentage of business miles as compared to total miles for the year.

• The maximum annual depreciation limits after deduction section 179 depreciation for vehicles purchased in 2001, whether you buy a Mercedes or a Ford are:

  • 2001 = 3,060

  • 2002 = 4,900

  • 2003 = 2,950

  • 2004 and after = 1,775

Let's try an example using actual expenses to see which is better: a lease or a purchase.

 

Expense Item	Lease	Purchase
Cost of vehicle	$22,000	$22,000
Value end of lease	$11,000	n/a
Pmt period	36 mo.	60 mo.
Monthly pmt	$418.03	$415.17
Inclusion amt 75%	$313.53	n/a
Interest rate	8%	5%
Interest exp avg./yr./five yrs.	n/a	$582.00
Business miles yr	8,000	8,000
Total miles per yr	10,000	10,000
Business %	80%	80%
Miles per gallon	25	25
Gas $1.35	$540	$540
Oil	$160	$160
Insurance	$1,200	$1,200
Repairs	None	None
License	$30	$30
Depreciation avg. 3 yrs.	n/a	$3,653
Net Lease pmt	$4,703	n/a
Total Cost for Yr.	$6,633	$6,195
Additional out of pocket for lease	$438
Tax savings at 42% @ 80% business	($148)
Net Financial Loss	$290
Financial loss over 3 yr. life of lease.	$872
Miles to breakeven(1)	$6,633 / $0.34 = 19,508 miles	$6,195 / $0.34 = 18,220 miles

1 - In this particular case, if the auto is driven more than these number of miles, it is better to use mileage to deduct your expenses.  If you are going to put heavy duty miles on a car, then mileage is always better--except in the case of a lease penalty clause.  Read more below.

Over the life of this lease, you saved on taxes, but lost financially.  Each lease needs to be individually analyzed to determine if a lease or a purchase would be better.  However, I will bet you that, while all leases are better tax wise, they are not always better financially.  The auto salesperson didn't lie to you, a lease is better tax wise; but, did he tell you the whole truth?  Interest rates on leases are almost always higher, and, if you put on a lot of miles (generally more than 15,000 per year), you will also have to pay a penalty.  When I grew in Chicago, they called this the poor man's purchase--it was for someone who couldn't afford a down payment and was, therefore, a greater finance risk which allowed for the higher interest rate.

What do you want?  Money in your pocket or a tax deduction!  You can't have both!

 

Top of Page This page was last updated on 01/26/2007