Vehicle purchases are one of the largest expenses for most families. With an increase in people choosing to lease instead of buy, what are the differences? As with most decisions in life, taxes should only be one of the considerations. A few of the non-tax considerations on buying or leasing a business vehicle: number of miles you drive each year, how long you keep a car, how much do you want to spend on your monthly payments?
You may be able to deduct your lease payment, prorated according to how much you use the car for business. For example, if your lease payment is $300 a month and you drive your car for business 50 percent of the time, you can deduct $150 a month as a business expense. There’s one catch though. If the car exceeds a certain value, you must subtract an “income inclusion” amount from your deduction. This is an additional amount of income you may have to report if you lease a vehicle or other property for business purposes. You must report the inclusion amount if the fair market value of the leased asset exceeds a certain threshold ($50,000 for a vehicle first leased in 2018). The inclusion amount differs depending on how long you’ve leased your car. Leasing offers tax advantages for self-employed people who drive for work, especially for more expensive cars.
As the price goes up on the car, leasing usually becomes more preferable. But don’t forget if you purchased the vehicle, you can also deduct the interest on the vehicle’s loan based on the percentage of business use. If you purchased a car this year to transport passengers for self-employment jobs like Uber and Lyft and you bought a sports utility vehicle, you may be able to deduct up to $25,000 of the cost of the vehicle if you use it more than 50% for your business. If you purchased a car for your business, you may also be able to deduct up to the depreciation deduction allowed if your business use is more than 50%.
With both purchased and leased cars, you can deduct the related expenses by using the standard mileage rate or actual expenses. Note: If you own the vehicle, you can choose the standard mileage rate in the first year and switch to the actual expense method in a later year if it becomes more favorable. If you lease a vehicle, you may also choose the standard mileage rate in the first year, but once you use the standard mileage rate you must use it for the life of the lease. In addition to mileage, you can also deduct business-related parking fees and tolls. Under the actual expense rules, for both leased and purchased vehicles, you can deduct the business percentage of your gasoline, oil, insurance, garage rent, parking & registration fees, lease or rental fees, repairs, tires, loan interest, etc. Some expenses differ between purchased and leased vehicles using the actual expense rules, and because you don’t own a leased vehicle, you can’t depreciate it.
There is one more difference between buying and leasing a business vehicle, which is the disposition of the vehicle. When you dispose of a business vehicle that you own, there may be a taxable gain or deductible loss. The portion of any gain that is due to depreciation will be taxed as ordinary income. When you return your leased car to the dealer, there is no taxable gain or loss.
If you are not looking at the tax deductibility of buying or leasing, then the benefit will really depend on other factors. Buying is usually the way to go if you have young kids or haul heavy machinery in your car. When you return a leased car, a little wear and tear is okay. However, the car needs to be close to its original condition or you’ll be charged for damages. Moreover, you may need to show documentation that you got all the recommended oil changes, tire rotations, and tune-ups. Usually, purchasing a pre-owned vehicle is the most financially savvy decision. That’s because you avoid steep first-year depreciation. On average, a new car loses ten percent of its value when you drive it away from the dealer and ten percent more during the next year. A new car loses an average of 60 percent of its total value during the first five years. Moreover, car insurance and vehicle registration fees are also usually lower for slightly used cars. However, maintenance and repair costs may be higher. If you can buy a pre-owned car with cash, you’ll skip interest payments and come out even further ahead financially.
Most car owners keep new cars for six years. If you plan to keep yours that long, buying is usually the better option, especially if you can pay off the loan during that time and build equity. It’s usually easier to get an auto loan than a good lease deal, especially if you’re rebuilding your credit. Leasing a car usually requires less expensive upfront costs and monthly payments compared to buying, but purchasing a vehicle is generally cheaper in the long run. Most leasing companies charge 12 to 15 cents for every mile driven over a set limit (usually 10,000 to 15,000 miles per year), which can add up. You can negotiate for a higher mileage limit, but you’ll probably have to pay more for the lease.
Leasing may make more sense if you are financing the entire purchase of a car you keep for less than three years usually doesn’t make financial sense. However, if a car is expected to have higher than average resale value, it may still be worth buying. When you lease, you only pay for the difference between the sticker price and the car’s expected value at the end of the lease, plus interest and fees. If you have excellent credit, you may not even need a down payment. It’s almost always cheaper in the short term to lease a car rather than buy it.
There are excellent financial incentives for purchasing a new electric car, including a federal tax credit and rebates in some states. However, eighty percent of electric car drivers lease. Why? First-year depreciation is even steeper for electric cars than for gas-powered cars. On average, electric cars manufactured in 2016 lost fifty-two percent of their value during their first year. Moreover, batteries degrade over time, and battery technology is quickly evolving. The electric vehicles manufactured in two to three years will likely have much better range than today’s electric cars.