Special limitations apply to the depreciation deductions for an
automobile used in your trade or business which may result in it taking
longer to depreciate a car than it would other business property.
First of all, note that a separate depreciation allowance for a car only
comes into play if you choose to determine the cost of its business use by
the “actual expense” method. If, instead, you use the standard mileage rate
(40.5 cents for each business mile driven during 2005), a depreciation
allowance is built in as part of the rate.
If you are using the actual expense method in calculating the
depreciation allowance, an automobile is treated as an asset with a 5-year
recovery period. Under the regular depreciation tables, automobiles are
actually depreciated over a 6-year span according to the following
percentages: Year 1, 20%; Year 2, 32%, Year 3, 19.2%, Years 4 and 5, 11.52%,
and Year 6, 5.76%. Six years are involved because depreciation starts in the
middle of Year 1 and ends in the middle of Year 6. (These percentages are
not available for cars used 50% or less for business purposes. For these,
straight-line depreciation is required.)
You are permitted to take 50% additional first-year depreciation (“bonus
depreciation”) for new tangible personal property (including automobiles)
that you predominantly use in your business and place into service before
2005. The adjusted basis of qualified property is reduced by the bonus
depreciation deduction before computing the amount otherwise allowable as a
depreciation deduction for the tax year and any later tax year. Thus, for
example, if in 2004 you place in service a qualifying automobile costing
$20,000, the first-year depreciation allowance is $12,000 [($20,000 × .50 =
$10,000) + (($20,000 − $10,000) × .20 = $2,000)].
However, under additional limitations applicable to cars, you are limited
to specified depreciation ceilings, under “luxury automobile” rules. These
ceilings, which are indexed for inflation, operate to extend depreciation
beyond the sixth year for cars costing more than what the total depreciation
allowance would be over the six years. For cars first put in service in 2004
and that qualify for the 50% bonus depreciation, the ceiling is $10,610 for
that year. If an automobile does not qualify for 50% bonus depreciation or
you elect not to claim any bonus depreciation, the ceiling is $2,960 of
depreciation for 2004. The ceiling amounts for later years (regardless of
whether any additional first-year depreciation applies) are $4,800 for the
second year, $2,850 for the third year and $1,675 for all later years.
Higher ceiling amounts apply for certain trucks and vans (passenger autos
built on a truck chassis, including SUVs and minivans) and electric
vehicles.
You cannot avoid these limitations via an election to “expense” the car
(a Section 179 election). With the limitations applying, it may take longer
than the regular 6 years to depreciate the entire cost of the car, if it is
not disposed of sooner.
If the car is used partly for business purposes and partly for personal
purposes, the limits are reduced to the business percentage. For example,
the maximum depreciation deduction for a car used 75% for business is $7,958
(75% of $10,610) for the first year (assuming the automobile qualifies for
the 50% additional first-year depreciation). The “personal” 25% portion
($2,652) is disallowed.
What is the impact of these limitations from the standpoint of the
business decisions you must make? They raise the “after-tax” cost of
automobiles used in your business. That is, the true cost of regular
equipment used in the business will be its actual cost reduced by the tax
benefits enjoyed via depreciation deductions. To the extent these deductions
are reduced (deferred to future years actually), the tax benefits are less
and the true cost is higher. It may be advisable to consider this factor in
deciding how much to spend on automobiles used in your business.
Please note that these limitations cannot be avoided by leasing a
“luxury” car instead of buying it. Although the mechanics of the tax rules
are different with leases, essentially your taxable income is increased to
mirror the tax savings you would have lost had you bought the car. (These
rules do not apply to car rentals for less than 30 days.)
