Contributed by: WrenD, FreeTaxUSA Agent, Tax Pro
If you use a car for your business, you probably know you can deduct some of the expenses related to its use. But what if you lease a car instead of buying one? Does that change how you report your car expenses on your tax return?
The answer is yes, there are some differences between reporting expenses for a leased vehicle and an owned vehicle. In this article, we'll explain what those differences are and how they affect your tax deduction.
Expense method
Initially, it's essential to choose between the standard mileage rate and actual expenses method for calculating your vehicle deductions. For more information on each, review this article.
The IRS requires you to use the same method every year you are deducting expenses for a leased vehicle. This leaves you with a tricky decision as to whether you want to deduct actual expenses or the standard mileage rate for the entire lease.
Reason to use the standard mileage rate include:
- Less documentation needed (only a mileage log)
- Simple tax reporting
- Often results in a higher deduction
Reasons to use the actual expense method include:
- Able to directly deduct vehicle expenses
- Usually results in a higher deduction if the vehicle is used mostly for business or if vehicle has a higher lease cost
In the first year you report a leased car, it's a good idea to try both methods in the software. From the start of the lease, make sure to keep track of everything needed. If you choose the standard mileage rate in the first year, you'll only need to keep a log of miles going forward. Items to track in the first year include:
- Business mileage
- Total mileage (when you need personal mileage, you can subtract business mileage from total mileage)
- Receipts for all fuel, oil changes, parking and toll fees, and other repairs
- Lease agreement and insurance policy documentation
Depreciation and lease payments
One of the main differences is how you handle the depreciation of the car. Depreciation is the decrease in the value of the car over time due to wear and tear, age, and other factors. When you own a car, you can deduct a part of the car's cost as depreciation each year. When you lease a car, however, you don't own it, so you can't depreciate it. Instead, you can deduct the business part of lease payments you make during the year.
Inclusion amount
When you lease a vehicle for business use for 30 days or longer you may have to decrease your lease payment deduction by an inclusion amount. This inclusion amount targets vehicles with greater value, such as those leased in 2023 with a fair market value exceeding $60,000. This threshold is subject to annual adjustments, so it's important to reference the limit for the year the lease began. Details on the inclusion amount and related guidelines can be found in Chapter 4 of IRS Publication 463.
Sales tax
Another item of consideration is sales tax. When you lease a car, you also pay sales tax on the lease payments. This sales tax isn’t part of the lease payment you can deduct. Instead, you must deduct the sales tax separately as a tax expense. To do this, you need to know how much sales tax you paid during the year. You can find this information on your lease agreement or your monthly statements.
Example and software entries
Consider this example: On October 10, 2022, Bonnie leases a Honda Accord and starts using it for Uber. In the current year, she drives 2,000 miles for Uber and 9,000 miles for personal use. Her monthly lease payment is $350, which includes $20 in sales tax. To enter her vehicle expenses, she follows this menu path:
- Income > Business Income (Schedule C)
- Select Edit next the business
- Select Edit next to Vehicle Expenses
- Complete the “Tell us about your vehicle” page
- Since she began using the car in 2022 most of the info is pulled from last year. She verifies all the info, particularly that “lease” is selected.
- She enters 2,000 business miles and 9,000 personal miles. Both mileage amounts MUST be entered for the software to calculate the correct amount of deductible vehicle expenses.
- Continue to “Tell us more about your vehicle”
- She leaves “Did you use more than four vehicles at the same time for your UBER DRIVING business?” as No.
- She answers “Have you previously used the Standard Mileage method for your HONDA ACCORD?” as no since she used the actual method in 2022 and must continue to use it.
- Continue to “How much did you pay to lease your Honda Accord”
- She remembers the inclusion threshold for 2022 was $56,000. As her Accord's fair market value was below this amount, she doesn't need to consider the inclusion amount.
- She enters $3,960 ($4,200 total lease payments – $240 sales tax) as her total lease expenses paid.
- Continue to “Tell us about these other vehicle expenses”
- She enters her expenses as follows:
- Fuel and Oil: $1,200
- Insurance: $800
- Repairs and Maintenance: $80
- Tires: $0
- Licenses and Registration Fees: $165
- Garage Rent: $0
- Miscellaneous Expenses: $0
- Lastly, from the “Your Business (Uber Driving)” page, she selects Edit next to Common Expenses
- Since sales tax needs to be reported on line 23 of Schedule C, she enters $44 for “Taxes and Licenses”.
- She figured out the business use percentage for her Accord as 18.18% by dividing her business miles by total miles (2,000 / 11,000). Then, she applied this percentage to the yearly sales tax, resulting in $43.63 ($240 * 18.18%).
Her Schedule C now reports her leased car expenses on three lines: line 9 reports the vehicle expenses, line 20a reports the lease payments, and line 23 reports the sales tax.
Reporting expenses for a leased vehicle on your tax return can be tricky, but it doesn't have to be stressful. If you understand the differences between leasing and owning a car, and the differences between the actual expenses method and the standard mileage rate method, you can make the best choice for your situation.
