This provision is in stark contrast to the previous law, which strictly limited the amount of depreciation allowed for luxury/passenger automobiles. So it almost seems too good to be true. Is it?
Here are several questions to ask before heading to the dealership.
Is your incentive to purchase a new 6,000-pound automobile just to take advantage of the tax break?
If it is, then what you are really doing is spending $50,000 (the approximate cost of a 6,000-pound vehicle) in order to save $20,000 in taxes, assuming that you are currently in the top tax bracket (35 percent plus 5 percent for state and local tax). If your adjusted gross income puts you in the 28 percent tax bracket, your tax savings would be $16,500.
That means that if you own a good, dependable car and really do not need a new one, you may unnecessarily spend $30,000.
Can you cash flow the monthly payments?
Just because you purchased a $50,000 SUV and you are going to be able to depreciate the entire cost of the vehicle in the first year of use doesn't mean you are automatically going to be able to fit the car's monthly payments into your business's budget.
First and foremost, make sure that you can afford the monthly payments.
What percentage of the time do you use your automobile strictly for business?
Often forgotten is the fact that the IRS will only allow business owners to deduct the costs of their automobiles to the extent that they use their automobiles for business. If you used a $50,000 SUV only 65 percent of the time for business use, you could only deduct $32,500 ($50,000 times 65 percent) of the cost of the vehicle.
That would equate to a tax savings of $13,000 for individuals in the top tax bracket. Again, you are spending $50,000 to receive tax savings of $13,000.
Do you need a 6,000-pound vehicle?
If you could be just as happy in a lighter, less expensive automobile, you might be surprised in the difference on savings ... even with the 6,000-pound tax break. Compare the savings if you use the vehicle for business only 65 percent of the time to a $30,000 passenger car, which would save you approximately $6,000 in taxes over a three-year period from depreciation alone. That's a net out-of-pocket cost of $24,000.
However, it is important to compare the potential gain or loss that you may incur when you sell the car. The SUV, which is fully depreciated, has no basis. That means that any amount of proceeds received from the sale would be taxable.
Assuming that the passenger car is sold after three years of service, it would potentially have a tax basis of approximately $9,000, which could be used to offset taxable income. This could potentially further reduce the net out-of-pocket cost of the $30,000 automobile to approximately $21,000 ($16,000 less than the $50,000 SUV).
It is rarely a good idea to spend money for the sole purpose of obtaining a tax break. CPAs cannot emphasize enough that each transaction should be reviewed based on your business's individual situation. In the case of the 6,000-pound vehicle deduction, if you can answer the above questions with regard to your individual status, you should have enough information to make an informed decision.
John McClary, CPA is a senior accountant in the healthcare and tax division of Heaton & Eadie. Reach him at (317) 581-9100, ext. 144, or email@example.com.