Car Depreciation: Complete Beginners Guide
Car depreciation is an unseen force that impacts every vehicle, whether you buy it new or used. For business owners who drive trucks, vans, cars, or SUVs for the purpose of carrying out business activities get the right to deduct a part of the cost with respect to the price of vehicle purchase from taxes that they are paying. The price of purchase is usually spread over the time period of a year to five under the process known as depreciation. There are a number of methods by which depreciation of such vehicles could be calculated and some of them might include MACRS (Modified Accelerated Cost Recovery System) depreciation, section 179 deduction, and the special depreciation allowance.
The Algorithm of Taxes and Depreciation: Not Very Complex Yet Professional Guidance is Important
No matter which type of method you choose for calculating the depreciation of your car, it is often recommended by the experts that hiring a tax professional or using software that gets accurate calculations will ensure that filing has been done in the correct way. There are a number of tax calculating software programs present on the internet that can look after several deductions of business along with calculating the depreciation of vehicles. Some of this software is free to use but its accuracy is questionable. On the other hand, there is some software that is accurate and you have to pay for them while filing.
How Does the Vehicle Depreciation Work?
When you drive your own vehicle for carrying out business activities, you are enabled to cut out the purchase price of the vehicle from the time period of a year to five. An entrepreneur can exclude apart from the total cost on the basis of percentage considering the distance covered by the vehicle during business concerns. Depreciation is a mathematical term and hence it requires a method to calculate, there are various methods by which vehicle depreciation could be calculated. We have mentioned section 179 and MACRS above along with that bonus depreciation is also very helpful in the calculation of car depreciation.
For the deduction of depreciation amount on a truck or car, it is essential for you to own it, use it for carrying out business activities and select the method of the actual expense. As we speak of business activities that involve vehicles, making a visit to clients, traveling to meetings related to business, delivery of products to the consumers are some of the prominent activities.
It is quite crucial to maintain records of track distance covered by the vehicle for proving that it has been used for several activities related to the business. There are a number of applications that might appear to be helpful in this case. In order to get a more detailed and thorough knowledge of the depreciation and its application, you can simply check it on several websites that include proper article, blog as well as a guide on this vast topic.
Sample Car Depreciation Formula:
Y = P * (1 – R/100)n
D = P – Y
- Y is the value of the car after n years,
- D is the depreciation amount,
- P is the purchase amount,
- R is the percentage rate of depreciation per annum,
- n is the number of years after the purchase.
You can also use our lease calculator to get an idea of the value “D” over years. We call this residual value on that page. Our numbers are generated based on industry sales trends and do not follow this simplified calculator.
Elaborating the Ways of Calculating the Vehicle Depreciation
If we speak of methods by which a vehicle’s depreciation is calculated, there are a few of them that could be considered as major ones. The section 179 deduction, as well as the special depreciation allowance, could be considered optional for the calculation depreciation as they can be used only with respect to the first financial year of the business. In simpler words, by these two methods depreciation on the vehicle could be calculated but only for the first year. On the other hand, the IRS recognized method MACRS depreciation is considered to be a standard method used for the evaluation of depreciation over five years.
Here are the merits of each method for depreciation evaluation, and those are-
- MACRS depreciation – in this method vehicle’s cost is spread over the time period of complete five years, in which deductions are more from one to three years and quite fewer deductions in the last two years
- Section 179 deduction – enables the deduction for about 25,000 dollars for a big vehicle like SUV used in business affairs for the very first year
- Special depreciation allowance – in this method the deduction of about 18,000 dollars is allowed for the car that has been used for carrying out business activities ( first year )
Always keep in mind that these three methods are very crucial and are often used for the evaluation of the depreciation of vehicles used for business affairs.
Understanding the Special Depreciation Allowance Method for the Evaluation of Vehicle Depreciation
The method of special depreciation allowance is also called bonus depreciation, it could be referred to as a bonus or additional depreciation amount that entrepreneurs could get at MACRS depreciations’ top. For the year 2018, the maximum amount limit on the depreciation of vehicles through special depreciation allowance was 18,000 dollars. This method could only be used for calculating the vehicle’s depreciation with respect to its business use for the very first year.
Special depreciation allowance and some of its major features:
- The benefit of getting a high amount of depreciation for the first year- 18000 dollars is the amount offered by special depreciation allowance that is much more than that of section 179 deduction and MACRS that is 10000 dollars
- It is only about the depreciation of the vehicle used for the first year in business- the special depreciation allowance is not applied after the first year, you can use MACRS after that
- No matter if the car is old or new- from the last couple of years the method of special depreciation allowance is used for old cars as well
- Business use more than 50%- in order to qualify for calculation a vehicle’s depreciation with special depreciation allowance method it is essential that the distance covered by the vehicle for business use is more than 50% of the total traveled distance
Along with that, this method is in use till the year 2027, and through the usage of form 4562, you can claim a special depreciation allowance.
MACRS Depreciation Method for Evaluation of Car Depreciation
It could be said it is the most popular method for the calculation of car depreciation. In this method, the car cost is spread over the time period of five years. As a depreciation calculating method, MACRS could only be used if the distance covered by vehicle for business use is more than 50% of the total traveled distance. You can use this method from the second year that is after calculating from section 179 deductions or special depreciation allowance.
MACRS Depreciation Method Key Features
As told earlier, it is a very important method used for evaluating the depreciation of vehicles that are used for business affairs. Some of its important features are:
- A large amount of deduction in the first and second year- the amount that is deducted through this method is larger as when compared with normal or straight-line depreciation method
- Business use of the vehicle must be more than 50%- the MACRS method could be used for calculating the depreciation of the vehicle only if it has been in use for more than 50% due to business-related works
- Calculated after section 179 or special depreciation allowance- when depreciation is calculated with this method, the adjusted cost of the car becomes the purchase value of the car and the amount came from section 179 deduction or special depreciation allowance is deducted from it
Along with the above-mentioned features, if used for the first year this method caps 10,000 dollars.
How depreciation deduction of a vehicle is calculated through the MACRS method?
The calculation of depreciation deduction of a vehicle used in business activities through the MACRS method is evaluated in two steps. The very first step is calculating the business part of the vehicle’s purchase value. The second step involves multiplication of purchase price’s business portion by the rate of depreciation with IRS
Utilizing the MACRS method’s depreciation chart. By following the steps below you can easily evaluate the deducted depreciation amount of a vehicle that is utilized in business affairs-
1- calculation of depreciable basis
- Percentage of distance covered for business use multiplied with vehicle’s basis
2- calculating tax deduction through the MACRS depreciation method
- The depreciation rate of MACRS multiplied with a depreciable basis
The information required for using the MACRS method in order to calculate vehicle depreciation
In order to calculate depreciation of vehicle with MACRS, the following information is required-
- Depreciable basis – it could be calculated by subtracting section 179 deduction or special depreciation allowance from the purchase value of the concerned vehicle
- Service date – it is referred to as the debut date of your vehicle in the business activities
- Period of recovery – the recovery period of cars is for the term of five years
- The depreciation method – the 200% method of declining balance could be considered as appropriate for vehicles
Now when you know all about the MACRS method, you can claim the amount of depreciation deducted from vehicles used in business.
Section 179 Depreciation Deduction Method for Cars that are Involved in Business Activities
The section 179 deduction enables the entrepreneurs to exclude about 10,000 dollars for normal cars and about 25,000 dollars for the specific type of SUVs and trucks. This method of depreciation is applied for the first year in which the vehicle gets involved with business purposes. The distance covered by a car must be more than 50% for business-related work in order to calculate its depreciation amount through the section 179 method. It is important to fill form 4562 for claiming the deduction of the section 179 method.
Section 179 Deduction Method Major Features
If you are calculating the depreciation of your vehicle with the section 179 deduction method, you must know some of its important features like:
- The depreciation amount for the first year is pretty impressive- most of the vehicles including cars get about 10,000 dollars
- Best for the vehicles that are big- when depreciation is calculated with this method the SUVs and trucks get the maximum benefit out of it as it caps about 25,000 dollars for them. Along with that, about 6,000 is offered with a gross rate of vehicle weight
- Limited to the very first year- this method is only used for calculating the first-year depreciation amount rest is the work of MACRS
- Business use should be more than 50%- in order to qualify for calculating depreciation through this method, it becomes quite important that the vehicle must have covered more than 50% only for the use of business-related work
The other best thing about this method is that it could be applied to brand new as well as old cars that are involved in carrying out several business activities.
How Depreciation is Calculated with the Section 179 Method?
With the simple process of two steps depreciation could be calculated through the section 179 method. The beginning step is to calculate the business part of the vehicle’s cost value, which is also referred to as a depreciable basis. The next step is comparing the amount to the maximum limit, which is 10,000 dollars in the case of cars and 25,000 dollars for heavy vehicles like SUVs and trucks.
The steps to calculate depreciation through section 179 deduction are as follows-
1. Calculating Potential Deduction of Section 179
- Percentage of business usage is multiplied with the vehicle’s basis and you get a depreciable basis as a result
2. The Deduction of Section 179 is the Lower of the Per Vehicle Limit or Depreciable Basis
- The section 179 deduction is not the higher of
- Depreciable basis or
- 10,000 dollars for several types of cars
- 25,000 dollars for heavy vehicles including SUVs and trucks that weigh about 6,000 pounds
The Limits of Vehicle Deduction Under Section 179
Usually, the entrepreneurs are restricted to the maximum amount of 10,000 dollars for normal cars in the last year. However, in the year 2017, the maximum amount was about 11,000 dollars in section 179 deduction. The higher amount of 25,000 dollars for the heavy-duty vehicles tends to have a 6,000-pound weight, it could also be considered as a limitation.
The maximum amount under section 179 deduction for last year includes:
- 10,000 dollars with respect to cars and other such type vehicles
- 25,000 dollars is the maximum amount for heavy vehicles that are more than or about 6,000 pounds in weight
- There are no limitations on the modified vehicles for business use like hearses, ambulances, tow trucks, and delivery vans
When we speak of the total purchased assets limit in section 179 deduction the amount is one million. This simply means that the maximum amount that could be deducted by applying section 179 for last year would be limited to one million.
The Limitation Regarding with Income of the Business Under Section 179 Deduction Method
Another limitation that comes in section 179 method is the annual income of the business. The most that could be done by using the section 179 method, is that the income on which tax might be imposed could be reduced to zero. In a simple way, this means if the depreciation of your vehicle is evaluated with the help of the section 179 deduction method, the loss could not be generated. No matter if the deduction amount in the section 179 method reaches a million it will be limited to the business’s net income for the year. For an instance, you have spent half a million on five vehicles in a year and your annual income is 20,000 dollars you could only claim for 20,000 under the section 179 deduction method and the remaining 30 will be carried forward to the coming years.
Life of the Vehicle Used in Business
While calculating the depreciation of the vehicle involved in business activities properly working life of the car is always concerned. To make it work, an entrepreneur can use-
- ATO determination – the standard rate as made by ATO that is annually published in the rules of taxation
- Self-assessed determination – on the basis of the vehicle’s features an estimate is made that is self-assessed according to the way the vehicle is being used
The type of business activities in which vehicles are being used is also very crucial. For instance, if the vehicle used for the business purpose involves cab services that count to about 60 hours in 5-6 days. The estimated best life of the vehicle will be about 5 years.
Claiming the Depreciation on Vehicle from Tax Returns
For claiming a reduction of vehicle depreciation, you are required to fill in form 4562. This form is for claiming MACRS depreciation, special depreciation allowance as well as for the section 179 depreciation deduction. Along with the vehicles, this form also includes all the other types of assets involved in the business.
It is advised to take help from professionals in order to get the accurate amount and avoid being in any kind of loss, as the business is all about the profit you make from it.
Documents that are Required for Vehicle Depreciation
According to IRS the business owners or entrepreneurs should have properly maintained a record of the expenses related to their vehicles. It is also advised to maintain a log that notes mileage proving that trips were really for business affairs. Along with that keeping records of cost price, date from which vehicle was being used in business as well as total distance covered every year. Keep accurate records as they may be audited.
Several records related to car depreciation asked by IRS may include:
- Purchase proof demonstrating the cost price of the vehicle
- Receipts of improvements and repairs done for the vehicle
- It is quite important to maintain a log that shows the distance covered by the vehicle, make it specific and detailed with destinations and dates
Along with that the date of the vehicle’s joining in the business with the total distance covered is also very important.
Car Depreciation FAQs
As we have discussed all the important aspects involved in the evaluation of vehicle depreciation in a business, let’s have a look at some of the frequently asked questions related to it.
What is Car Depreciation?
When a vehicle is purchased for carrying out several business activities, the entire cost could not be returned on the tax return in that particular financial year when the vehicle was bought. In that way, depreciation is quite beneficial as the deduction of a portion is done every year on the vehicle justifying its cost.
What if the vehicle is not used more than 50% for business activities?
It is possible to claim a deduction of depreciation from the tax return even if the use of a vehicle for business activities is 50% or less than that. In the case of less than 50% usage, the depreciation of the vehicle could be calculated with the help of the straight-line method for the time period of five years. However, the vehicle would not qualify for a special depreciation allowance or section 179 deduction method.
What would be the depreciation cost of a car that is on the lease?
If a leased vehicle is used for the activities of your business, it could not be depreciated. In place of that, one may deduct portions from the payments of the lease. The deducted part from lease payments will only involve business affairs as it will be calculated by use of the vehicle for business in percentage. The lease deduction amount is less in the next time as per publication 463 of the IRS.
There are several other questions as well like required documents, methods, and many more but these are already explained above.
You might have gained the complete knowledge of depreciation on vehicles used for business as well as several aspects related to it. However, if you are thinking of filing all the forms and calculating the amount of depreciation by any of the methods explained above on your own, you are free to think that as there is no loss in thinking. But just don’t do it because such things should be handled by professionals only. All you have to do is get the right man at the job and avoid any kind of loss in your business. Doing so in a systematic way might help to maintain the accounts’ book properly for your audit purposes.