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.


Anonymous said...

What about the 2008 rule that allows you to depreciate up to $25,000 in the first year and the remaider through year five for a business vehicle that weighs over 6000 lbs. I believe a truck with a 6' bed or longer can be at 100% in the first year. Any thoughts? Some SUV weights do qualify.

Mark Hunter said...

Thanks for explaining this. I never understood why leasing was always mentioned as preferable for business use. I always figured that depreciation on a purchase was just as good. Compounding my confusion was the fact that I bought a "heavy vehicle" in 2008 and was able to take a Section 179 deduction and depreciation nearly the entire purchase in one year. I forgot that Section 179 deductions are the exception, not the rule.

Anonymous said...

You sir, are an idiot.

Unknown said...

It's always nice to get helpful criticism. "Anonymous" could have explained what was idiotic about this post, or even suggested how to provide better information. Instead, we get a rather unhelpful comment.

I invite anyone with better information to educate me, along with those who read this blog post.

Rob Naro said...

This is a very well written article and even though its dated it helps me see it more from a client point of view. I've never understood why one of the questions I get asked most is lease or buy but its good to see what info is being put out there and contributing to the popular notions. The one glaring omission in this article is the standard mileage deduction. I like to think the author got his Porsche so it won't matter for him but for those of us driving Kia's and racking up major mileage you will probably want to use the standard mileage method after you purchase your vehicle and skip the lease. The reason is that this method is generous and isn't indexed for the type of vehicle. The cheaper you buy your car, the better the deduction you get. For instance, my first year as a tax accountant I was lucky enough to purchase a vehicle for $1,000 from a family friend. The car was a steal and lasted me 5+ years with minimal repairs. Because of low cost of ownership my only real cost was fuel and maintenance. My deduction far exceeded my actual cost by thousands of dollars every year and was a completely legal deduction. The more miles a person drives the bigger this gap is. For instance in 2011 the deduction was 51 cents per mile. For a sales person driving 30,000 miles per year this is a deduction of $15,810 dollars per year. That is tough to beat with actual expenses on a cheaper car even if new. Also keep in mind that depreciation runs out, the standard mileage rate does not. So in the above scenario you could take that $15,810 deduction for the next 10 years if you keep your car that long and it lasts 300,000 miles (I know, extreme). Still, you can see how a person in the right situation could really use this to their advantage.