Advantages of Actual Expense Method Versus Standard Mileage Rate Under the New Tax Law

You could get much larger deductions using the actual expense method instead of the standard mileage rate under the new tax law.

The new tax law changes the amount of the deduction you can get using the actual expense versus the standard mileage rate for business driving expenses. Specifically, if you purchase an expensive car to use in your business, you could get much larger deductions under the new tax law using the actual expense method instead of the standard mileage rate. This is the result of the larger annual depreciation deduction you can take for vehicles under the new law. Here's how it works.

You are allowed to deduct your driving expenses when you drive your car for business. There are two ways to calculate your deduction: you can use the standard mileage rate, or you can deduct your actual expenses. With the standard mileage rate, you deduct a set amount for each business mile you drive. The amount is set by the IRS each year. For 2018, the standard mileage rate is 54.5 cents per business mile. When you use the standard rate, you don’t need to keep track of how much you actually spend for gas, repairs, and other car expenses during the year. All you have to do is track your business mileage and total annual mileage. Most people use the standard mileage rate because it’s the simplest and easiest method.

If you use the actual expense method, in additional to tracking your mileage, you must keep track of all your car expenses, including gas, insurance, and repairs. You then deduct the business percentage of these expenses. You are also allowed to deduct an amount for depreciation each year. However, unlike with other business assets, the depreciation deduction for passenger automobiles is strictly limited by the tax law. A passenger automobile is any four-wheeled vehicle made primarily for use on public streets and highways that has an unloaded gross weight of 6,000 pounds or less. In 2017, for example, the maximum amount of depreciation that could be deducted for a passenger automobile the first year it was placed into service was $3,160; plus an additional $8,000 could be claimed if the vehicle qualified for bonus depreciation. It didn’t matter how much your car cost, this was the maximum you could deduct.

The Tax Cuts and Jobs Act (“TCJA”), which took effect January 1, 2018, has not removed the annual limits on passenger vehicle depreciation, but it has greatly increased them. The chart below shows the maximum annual depreciation deduction allowed for passenger automobiles placed in service in 2017 and 2018.

Depreciation Limits for Passenger Automobiles

(must be reduced by percentage of personal use)

2017 Amounts Pre-Tax Cuts and Jobs Act

2018 Amounts Post-Tax Cuts and Jobs Act

First year vehicle placed in service

$3,160

$10,000 (plus $8,000 bonus depreciation, if applicable)

Second year vehicle placed in service

$5,100

$16,000

Third year vehicle placed in service

$3,050

$9,600

Fourth year vehicle placed in service and later

$1,875

$5,760

If you place a passenger vehicle into service in your business in 2018, you may now take a maximum depreciation deduction of $10,000, far more than the $3,160 allowed under prior law. The second year, you may deduct a whopping $16,000. That’s $26,000 in depreciation deductions in the first two years. These are by far the highest annual limits for passenger vehicle depreciation that have ever been allowed.

If your vehicle qualifies for bonus depreciation, you may deduct up to $8,000 more the first year. However, you may take bonus depreciation only if you use your car for business over 50% of the time during year.

These annual limits are based on 100% business use of a passenger automobile. If you use your car less than 100% for business, you must reduce your limit accordingly. For example, if you use your car 60% for business in 2018, your annual limit is $6,000 instead of $10,000 and you may claim $4,800 in bonus depreciation (60% x $8,000 = $4,800).

Moreover, your actual depreciation deduction, up to the annual limit, depends on the cost of your car and how much you drive for business. If you drive less than 50% for business, you must use the slowest method of depreciation, called the straight-line method. If you drive more than 50% for business, you may use accelerated depreciation that gives you larger deductions in the first few years. The amounts you can deduct each year with these methods are shown in the following chart:

Year

Straight-Line Method

Accelerated Depreciation (200% Declining Balance Method)

1

10%

20%

2

20%

32%

3

20%

19.2%

4

20%

11.5%

5

20%

11.5%

6

10%

5.76%

Example: Jean purchases in 2018 a $60,000 passenger automobile she uses 60% of the time for her real estate brokerage business. Her depreciable basis is $36,000 ($60,000 cost x 60% business use = $36,000 basis). Since she uses the vehicle more than 50% for business, she may use accelerated depreciation. Using the 200% Declining Balance Method, her depreciation deduction for 2018 is 20% x $36,000 = $7,200, well within the $10,000 annual limit. Jean may also take bonus depreciation in 2018, which is an additional $4,800 deduction (60% of the $8,000 maximum bonus depreciation deduction). Her total 2018 depreciation deduction is $12,000. In 2019, she may deduct 32% x $36,000 = $11,520. She also gets to deduct 60% of what she spends to drive her car each year, including gas and repairs. If Jean uses the standard mileage rate instead, she can only deduct 54.5 cents for each business mile she drives in 2018. She would get no additional deduction for depreciation (the standard rate includes depreciation). If Jean drives 20,000 miles for business during year year, her total deduction using the standard rate would be $10,900.

The bottom line is you could get much larger deductions in the first several years after you purchase a car for business using the actual expense method instead of the standard mileage rate, particularly if you purchase an expensive vehicle. To be safe, you may want to keep track of all your expenses and mileage the first year you purchase a new car for business. Then when you do your taxes for the year, you can calculate what your deduction would be using both methods. You can then choose whether to use the actual expense method. If you do so, however, you’ll have to continue to use this method for as long as you own your car. You’re allowed to use the standard mileage rate only if you use it the first year you use your car for business.

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