TAX DEPRECIATION OF VEHICLES - AIPB

Section 8

TAX DEPRECIATION OF VEHICLES

Introduction

For tax depreciation purposes, a vehicle is generally placed into one of three general categories. Some categories have dollar limits on Section 179 expensing or depreciation, some on both, some on neither. All vehicles are 5-year property (have a 5-year recovery period)

The three categories are as follows:

1. Passenger automobiles. Under tax law a passenger auto is "any four-wheel vehicle made primarily for use on public streets, roads, or highways and rated at 6,000 pounds or less of unloaded gross vehicle weight." This includes most cars and "light" (up to 6,000 pounds) SUVs, pickups or vans not "specially modified" (see below). All passenger autos are subject to annual IRS limits for combined Section 179 expensing and tax depreciation. 2. Heavy SUVs, pickups and vans. These are vehicles that weigh more than 6,000 pounds, but less than 14,000 pounds. Section 179 expensing is limited to $25,000 but there is no limit on annual depreciation. 3. Other vehicles. These are vehicles that do not fit in the first two categories. They have no limits on Section 179 expensing or annual depreciation. Other vehicles include the following:

specially modified vehicles. "Specially modified" has a specific meaning under tax law. It means modified in a way that makes it unlikely that the vehicle will be driven for personal use; such as modified so that there is seating for only a driver and one passenger.

vehicles weighing at least 14,000 pounds (e.g., tractor-trailers and construction vehicles); and

larger delivery trucks, hearses, taxis ("used in the trade or business of transporting people for pay or hire"), and delivery vehicles ("used in the business of transporting property for pay or hire") and trucks not designed to carry passengers.

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EXHIBIT A Passenger Autos Placed in Service in 2012

1st year

Autos (cars)

50% bonus taken

No bonus taken or used vehicle

$11,160

$3,160

Light SUVs Pickups and Vans*

50% bonus taken

No bonus taken or used vehicle

$11,360

$3,360

2nd year

5,100

5,100

5,300

5,300

3rd year

3,050

3,050

3,150

3,150

4th year and after 1,875

1,875

1,875

1,875

* Weigh 6,000 pounds or less and are not specially modified.

Depreciation Limits on Passenger Autos

Under MACRS, annual depreciation of a company car is computed in the same way as other 5-year equipment. But the amount of depreciation allowed each year is limited, as shown in Exhibit A above. There is one set of IRS limits for autos (cars); another for light SUVs, pickups and vans weighing 6,000 pounds or less that are not specially modified. Note the difference in the IRS limits between new and used vehicles throughout the recovery period.

In each year, you must compute Table 1 depreciation for the car, compare it to the IRS limit, and use the lower amount. Important: The IRS publishes this limit table each year, adjusting the limits for inflation. However, you must use the IRS limits for the year in which the car was acquired throughout the car's recovery period.

EXAMPLE 1: On July 6, 2012, StudCo acquires* a new passenger auto with a cost basis of $28,000. What is Table 1 depreciation (see page 147) for Year 1? What is the IRS limit for Year 1? Which amount must StudCo use for its tax return? What is StudCo's maximum depreciation deduction for each subsequent year?

*Under both generally accepted accounting principles (GAAP) and tax law, depreciation cannot begin until the asset has been acquired and placed in service. However, to avoid cumbersome, repetitious language ("acquires and places in service . . ."), it is assumed throughout this course that the acquired asset is placed in service on the date of purchase.

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To compute Year 1 depreciation: $28,000 cost basis ? 50% bonus depreciation rate = $14,000 bonus depreciation. $28,000 cost basis ? $14,000 bonus depreciation = $14,000 new cost basis ? 20% Table 1 rate for Year 1 depreciation = $2,800 + $14,000 bonus depreciation = $16,800 total depreciation for Year 1. But the IRS Year 1 limit for a new passenger auto purchased in 2012, (Exhibit A) is $11,160. StudCo can take only $11,160 depreciation the first year. The $5,640 excess ($16,800 depreciation ? $11,160 limit) will be taken in later years. The schedule below shows tax depreciation for the auto over its recovery period.

Cost basis

StudCo's Annual Tax Depreciation for the New Car

Depreciation rate Computed

(Table 1)

depreciation

IRS Limit (2012)

Tax Return Depreciation

Expense

Depreciation deferred

Year 1

$28,000

?

14,000*

?

Year 2

14,000

?

Year 3

14,000

?

Year 4

14,000

?

Year 5

14,000

?

Year 6

14,000

?

Year 7

Year 8 Year 9

Year 10 Total

50.00% 20.00 32.00 19.20 11.52 11.52

5.76

$14,000 2,800 4,480 2,688 1613 1613 806

$11,160 5,100 3,050 1,875 1,875 1,875 1,875 1,875 1,875

$11,160 4,480** 2,688*** 1,613 1,613 806 1,875**** 1,875 1,875 15

$28,000

$5,640 -- -- -- -- --

3,765 1,890

15 0 0

*Revised cost basis ($28,000 original cost basis ? $14,000 bonus depreciation).

**Year 2 computed depreciation of $4,480 is lower than the IRS limit of $5,100. Because the company must always use the lower amount, StudCo can take only $4,480 depreciation in Year 2.

***The company must use the computed depreciation of $2,688 because it is lower than the IRS limit of $3,050.

****In Year 7, the company can start to take the $5,640 of depreciation deferred in Year 1. It can take up to the IRS limit of $1,875 per year until it has depreciated the full cost basis of $28,000. To allow for full depreciation of the cost basis, the recovery period is extended to 10 years.

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Mastering Depreciation

EXAMPLE 2: On July 6, 2012, StudCo acquires a used passenger auto with a cost basis of $28,000. What is Table 1 depreciation for Year 1? What is the IRS limit for Year 1? What is StudCo's maximum depreciation for Year 1?

To compute Year 1 depreciation: $28,000 cost basis ? $20% Table 1 rate for Year 1 = $5,600.

The IRS Year 1 limit for a used passenger auto purchased in 2012 is $3,160 (Exhibit A, page 188).

StudCo's maximum depreciation for Year 1 is $3,160. The $2,440 excess ($5,600 Table 1 depreciation ? $3,160 limit) will be taken in later years.

Why Sec. 179 Is Rarely Used for Passenger Autos

Under IRS Year 1 passenger auto limits--$11,160 for a new auto and $11,360 for a new light SUV, pickup or van--there is no point in wasting part of the $139,000 Sec. 179 deduction, because it would exceed the deduction allowed.

Sec. 179 limits on heavy SUVs, pickups and vans. For any heavy SUV purchased after October 22, 2008, the Sec. 179 deduction is limited to $25,000.

Exhibit B. Summary of annual tax deductions for vehicles

Section 179 deduction ($139,000 in 2012)

Depreciation

Passenger autos (includes unmodified light SUVs, pickups and vans)

Rarely used

Apply the lesser of IRS limits or Table 1.

Heavy SUVs, pickups and vans

Up to $25,000

Table 1

Other vehicles

Up to $139,000

Table 1

The remaining cost basis after the Sec. 179 deduction is taken can be depreciated using Table 1.

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EXAMPLE 3: During 2012, StudCo purchases a new, heavy SUV with a cost basis of $27,000. What is StudCo's maximum tax deduction for the heavy SUV for 2012? To compute: $27,000 cost basis ? $25,000 maximum Sec. 179 deduction for the heavy SUV = $2,000 new cost basis $2,000 revised cost basis ? 50% bonus depreciation rate = $1,000 bonus depreciation $1,000 new cost basis ? 20% Table 1 depreciation = $200 new cost basis Year 1 depreciation $25,000 Sec. 179 deduction + 1,000 bonus depreciation + 200 Table 1 depreciation $26,200 maximum tax deduction for the new, heavy SUV in 2012.

When Employees Drive Company Vehicles for Personal Use

A company can treat a vehicle as though it were used 100% for business even when employees drive a company vehicle for personal use under the following conditions:

1. the employer has a business reason for providing the vehicle, such as for business travel or as part of the employee's compensation as a perk for the job; and 2. the employer reports the value of the employee's personal use as taxable income on the employee's W-2.

EXAMPLE 4: MatCo provides a passenger auto to employee Lee who periodically submits detailed records of business and personal mileage. For the year, Lee drives the car 80% for business and 20% for personal use. If MatCo includes the value of the 20% personal use in Lee's taxable income, the company can depreciate the car as though it were used 100% for business.

The Sole Proprietor's Company Car

A sole proprietorship (an unincorporated company with one owner), like a corporation, can depreciate a vehicle as though it were used 100% for business

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