The U.S. tax laws allow businesses to recover the cost of purchasing tangible assets through a process called depreciation. When you depreciate an asset, you deduct a part of its acquisition cost each year over a recovery period specified by the IRS. Normally, the useful life of a car for depreciation is five years, but you may be able to cut the depreciation period down to just one year if you satisfy certain criteria.
The IRS provides the Modified Accelerated Cost Recovery System (MACRS) to specify tax deductions and recovery periods for depreciable items. Under MACRS, a vehicle is classified as five-year property. In actuality, it takes six calendar years to fully depreciate a car, truck or van, because MACRS assumes you put the vehicle into service at mid-year. Therefore, a business or self-employed individual depreciates a car for one-half year in years one and six, and over the full year for years two through five.
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Consider also: How to Calculate Depreciation on Schedule C
You can choose among two accelerated depreciation methods (the 200 percent declining balance [DB] method and the 150 percent DB method), and the straight-line method. If you use a DB method, you must switch to the straight-line method when that method gives you an equal or greater deduction. A MACRS Depreciation Chart, available in IRS Publication 463, explains how to figure your depreciation deduction for each year during your vehicle's recovery period.
Consider also: The Most Common Depreciation Methods
Section 179 Deductions
The Section 179 tax rules allow a business to deduct all at once the purchase cost of certain depreciable property, including cars, vans and trucks. This means you can recover the full cost of your vehicle in the same year you put it into service.
You can apply Section 179 for deductions up to $1,050,000 in 2021. There is a cap of $2,620,000 on spending for property that qualifies for Section 179 treatment (i.e., Section 179 property). After hitting the cap, you must reduce your Section 179 deduction dollar for dollar by the amount exceeding the cap.
Certain heavy sports utility vehicles are subject to a Section 179 deduction limit of $26,200 in 2021. Generally, this limit applies to four-wheel-drive vehicles with a gross weight exceeding 6,000 pounds. Section 179 limits are annually adjusted for inflation.
Special Depreciation Allowance
Often called "bonus depreciation" the special depreciation allowance (SDA) allows you to deduct 100 percent of your vehicle's cost in the year it was first put into service. You figure SDA after first applying your Section 179 deduction but before the MACRS depreciation deduction.
In 2021, the maximum depreciation you can take on vehicles to which first-year bonus depreciation applies is $18,200 per vehicle. The limit decreases in each remaining year over the full five-year recovery period as you continue to depreciate the vehicle under MACRS rules.
If you don't claim the bonus deduction, the deduction limit per vehicle is $10,200 when the first tax year is 2021. The same second- through fifth-year deduction limits apply whether or not you took the bonus deduction.
It's important to be aware of certain special considerations that impact how you deduct depreciation costs on vehicles. These include the following:
- You can't claim Section 179 depreciation on vehicles that receive 50 percent or less qualified business use in the year placed into service. For vehicles that receive 51 percent to 99 percent qualified business use, you prorate the 100 percent deduction amount.
- The adjusted cost basis of a vehicle is its original cost (including sales taxes destination charges and dealer preparation) plus any added improvements minus depreciation and certain fuel-related items. If you sell a vehicle for more than its adjusted basis, you must report the gain as ordinary income rather than a capital gain.
- If you took the standard mileage rate deduction on your vehicle during the first year of business use and subsequently changed to the actual expenses method, you cannot use MACRS to figure your depreciation deduction. Instead, you must use straight-line depreciation.
Consider also: How to Write Off Mileage on Taxes