Saturday, August 02, 2008

Tax Benefits of Leasing a Car - IRS Depreciation Limits

I've been thinking about leasing a car (see my previous post about leasing certified pre-owned cars). My accountant told me to lease. But I like buying. I know there's a tax benefit to leasing, but I don't really understand it.

If I was smart I would have asked my accountant to explain it to me. But I figured it should be simple to find out why by looking on the internet. It was more of a struggle than I wanted, but I think I figured it out now.

The reason leasing is better in my case is the way the IRS limits depreciation of a car as a business expense. There's a chart on that web page, several screens down from where the link takes you.

Basically, you can depreciate up to around $3000/year. The schedule on the above page says $3060 in the first year, $4900 in the second year, $2850 in the third year, and then $1775 each year afterward. This is for cars placed in service in 2007. For three years the total limit is $10810. So if you buy a $30K car. You actually lose about $15K in real-world depreciation, but you can only expense about $11K of that. And it'll take over 10 more years to depreciate the rest of the car.

If you lease a car for business alone, you can expense the entire lease payment. If you use it 85% for business, then you can expense 85% of it. (*Please note I am not a tax lawyer or accountant. I'm just going on my gut here.*)

The logic is more compelling on more expensive cars. If you buy a $50K car, you lose maybe $25K in actual depreciation but you can still only expense $11K of that. And it'll take 22 more years to fully expense the car.

Here's a more specific example - I've been thinking about a 2008 Acura MDX. There is a current offer to lease for 3 years, $499/month, with under $1000 down payment (with another $1000 in up-front expenses), and I think it's a 12,000 mile per year lease.
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So if you lease, you expense $499/month, or $6000/year. Over three years you expense $18,000. If you are in a 50% tax bracket (including FICA, state taxes, etc), then the expensing saves you $9000 (if I have this concept right). In net this cost you $9000 over three years, and you now own nothing.

If you buy now, you'd probably pay somewhere between $35K and $40K for that model - call it $36K. And there's a deal for 1.9% APR for 36 months, or 3.9% APR up to 60 months. At 36 months and zero interest (I'm tweaking the numbers to make buying better), you'd pay $1000 per month (Ouch!). In three years you'd own the car - a nice plus. But you would have expensed only $11K, and you would have saved $5500 in taxes instead of saving $9K on the lease. So you spent $36K on the car. You saved $5500 through depreciation, so net you spent $30K. You now own a car worth $20K. Sell the car and you spent $10K and now you own nothing. Leasing saved you $1000.

I tweaked my numbers pretty heavily in favor of buying there, and leasing still came out ahead.

This seems really dependent on how the car's value actually holds up. In one of my current fantasies I get a $80K Porsche (2009 911 Carrera 4 with the DSG). If the car loses half its value in 3 years, but Porsche's seem to hold their value better. Shopping for used ones, it looks like a $75K car is still worth close to $60K three years later. But Porsche leases seem to be priced as if they lose half their value in three years. That makes buying seem more attractive.

Comments appreciated, especially from anyone who really understands how this stuff works.
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