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How To Depreciate Your Vehicle for Tax Purposes
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How To Depreciate Your Vehicle for Tax Purposes
Our cars are almost as much a part of life as our homes are. Many of us spend a good chunk of our lives in them, going to and from work, driving the kids to all the things we drive them to and taking the all-American road trip (at least when gas prices allow). We're even capable of getting attached enough to our cars to give them names.
There's a lot we couldn't do without our cars, and because they're so necessary, we spend the money we need to get a hold of a car that satisfies our needs and keep it running safely. Sometimes that cost can make a noticeable difference in our overall finances. But not everyone thinks to ask, "Is depreciation tax deductible?" Which can be unfortunate because the answer is yes, owning and using your car can be a significant expense, but it can also give you a tax break.
Key takeaways
- There are two formulas to calculate depreciation deductions, and you'll need to decide which is best for you.
- Depreciation spreads the value of a car over the whole of its useful life.
- A few trusted sources, including the IRS, decide how that value is distributed for each make and model of car.
Table of contents
What is vehicle depreciation?...Read more
What is vehicle depreciation of cars based on?...Read more
How much does a car depreciate per year?...Read more
What is a car depreciation tax benefit?...Read more
The standard mileage deduction...Read more
The actual car expense method...Read more
Is depreciation tax-deductible?...Read more
What is form 4562?...Read more
What is vehicle depreciation?
Appreciation is when something you own that can be considered an asset, like a house or stock in a company, increases in value over time. This can happen because of increased demand, dwindling supply or market forces like inflation or interest rates.
Depreciation is the opposite of this. It actually refers to an accounting method that takes the initial cost of an asset, in this case a car, and spreads it out over the "useful life," according to the IRS, of the car. This makes it easier to know how much value a car has at any given point in its life.
What is vehicle depreciation of cars based on?
Say you were car shopping and had your heart set on a Subaru Impreza. A 2022 Impreza will cost more than a 2016 Impreza because of depreciation, which calculates how much value is left in the car after six years of use.
Those six years can amount to a lot of use and, therefore, a lot of wear and tear. That's why anyone who finds a used car with low mileage is always excited. They're paying for the car based on standard depreciation rates, even though it has not been used as much as other cars that age normally would have been.
There's another reason older car models can't hold a candle to newer ones: car companies are always adding new features and improving existing ones. A good car depreciation calculator can take these things into account to give you an accurate amount of vehicle for your specific vehicle.
How much does a car depreciate per year?
There are different formulas accountants use to calculate the depreciation of an asset, and we're not even going to try to list the numbers and symbols here. Luckily, you can leave it to experts like the Kelley Blue Book and the National Automobile Dealers Association, or NADA, to know how to calculate depreciation.
These resources publish the values of hundreds of makes and models of cars each year, so you don't have to do any math to find the fair market value of the exact car you have or want to buy. You can also use one of the many options out there for a car depreciation calculator.
The factors these organizations take into account are no surprise. They're all the things you would look for if you were looking to buy a used car.
Make and model
Mileage
Condition
What is a car depreciation tax benefit?
Some tax deductions seem obvious to most of us, like when you donate to a charity and you can write the amount of that donation off from your taxable income at the end of the year. But it seems a lesser-known fact that auto depreciation can be written off from your taxes if you own the vehicle you use for your business as a freelancer or self-employed individual.
The idea here is to spread the cost of the car, as a tax-deductible expense, out over the whole of its useful life, rather than writing off the sale of the car from your taxes in one go. This way, if the car has different owners over the course of its useful life, everyone gets a piece of the car depreciation tax value in the form of a deduction.
And you can take that deduction in two ways.
The standard mileage deduction
This is a great option for truckers, delivery drivers or people who drive for Uber or Lyft because it gives you a deduction for each mile you drive for work throughout the year.
The IRS posts a new mileage rate each year that you can use to calculate your write-off. This is supposed to take into account all the car expenses normally associated with owning a vehicle, like gas, maintenance, insurance and depreciation. Because gas prices went up so much halfway through the year, the IRS changed the rate mid-year from $0.585 per mile to $0.625 to give drivers a bigger tax break and offset the cost of gas.
If you started working for Postmates in the last four months of 2022, and you drive 6,000 for work during the year, you'd be able to write off 6,000 X $0.625 = $3,750. Just make sure you don't count the miles you spend commuting or driving between home and work. If you have a home office, you can deduct your first and last trip of the day when you are out and about away from your home office.
The actual car expense method
With this method, you can deduct a percentage of the amounts you actually spend on vehicle costs, such as gas, repairs, insurance and vehicle registration and of course, depreciation. This method requires detailed record-keeping. But instead of using spreadsheets and saving your receipts, FlyFin takes the work out of this by tracking car expenses and all of your freelancer expenses using a powerful A.I. The app is backed up by expert tax CPAs who are available for any questions you have 24/7, who also help you prepare and file your taxes.
Is depreciation tax-deductible?
Both these methods make car depreciation tax deductible, but with the standard mileage deduction, it's already built in. Here's how to calculate car depreciation using the actual car expenses method. First of all, the depreciation value has to be based on business usage, which is the number of miles you use the car for business rather than personal usage.
If your Postmates gig is part-time, and that 6,000 miles you drive for work each year is you drive another 10,000 in personal miles, you'll need to divide those business miles by the total of 16,000 miles to get 0.38 (38%). This is your business use percentage, which you can now apply to your basis
What's a basis, you ask? This is the amount that you've sunk into buying your car. If you purchased your vehicle for $11,000 total after paying tax, registration and any other fees. It doesn't matter if you paid for it in cash or used financing to sign on the dotted line. This is your basis.
But because most of us don't use our car strictly for business purposes, we have to apply that business use percentage to our basis to get our depreciation value, so we know what we can write off taxes. In this case, your depreciable basis is $4,180. If this seems like a lot of work, you can use a business vehicle depreciation calculator as long as it's coming from a source you trust.
What is form 4562?
This is the IRS tax form you'll use to report depreciation on your vehicle. The IRS doesn't allow you to deduct the full cost of any asset you purchase in the first year you own it from your taxes. Instead, you need to spread the deduction out over a handful of years, and that's what the IRS form 4562, Depreciation and Amortization, is for.
In the case of your car, the amount you're able to deduct will depend on the useful life that the IRS estimates for it each year, and you'll need to take that into account using IRS sources when filling out Form 4562.
It might seem like a lot of work to calculate the depreciation of your car and figure out how much you use your car for business, but your vehicle depreciation deduction might be one of the biggest you have for the year. And it's essential to help you decide whether the standard mileage rate or the actual expenses method will save you more.
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