How to Calculate Vehicle Depreciation based on IRS Guidelines

If you own a vehicle that is used for business, you can claim vehicle depreciation as a business expense. In this article, we cover when and how you can do this.

How to Calculate Vehicle Depreciation based on IRS Guidelines
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Vehicle depreciation is the decrease in the value of a vehicle over time. The IRS allows businesses to write off the cost of certain assets, such as vehicles, over their useful lives through a process called depreciation.

You can depreciate a vehicle if it meets the following requirements.

  • You or your business owns the vehicle (i.e. not a rental or leased vehicle).
  • It must be used in your business or income-producing activity.
  • It must have a determinable useful life.
  • It must be expected to last more than 1 year.

When can you deduct vehicle depreciation?

The first aspect of calculating and deducting vehicle depreciation from your taxes is understanding if you are eligible for tax savings. Vehicle depreciation deductions are only eligible for taxpayers who:

  • Use their vehicle only for work - in this case, the entire depreciation value of the vehicle is tax-deductible.
  • Are self-employed and use their vehicle for their business, but also for personal purposes - in this case, the vehicle must be used at least 50% for business in order to be eligible for deduction of depreciation cost. Further, only the business portion of the vehicle depreciation is tax-deductible.
  • Employees using their personal vehicles for work may use the actual expenses method to deduct or reimburse vehicle depreciation (among other vehicle expenses). Again, the employee must use the vehicle predominantly for business (50% or more) and must then prorate the depreciation value to the business use of their vehicle.

This is important to understand before making any deductions because even if you drive to work in your vehicle, you may not be eligible to deduct all (or any) of the depreciation of your vehicle.

The vehicle's cost-basis

The cost basis of the vehicle must be determined in order to calculate depreciation. The basis of a vehicle you buy is its cost plus any amounts you paid for items such as sales tax, freight charges, registration, and testing fees.

If you own a vehicle for personal use and later use it for business, your cost basis will be the Fair Market Value (FMV) at the date you first placed used the vehicle for business.

The business use of vehicle

In reality, a vehicle is usually used both for business and personal purposes. It is therefore crucial to track your mileage in order to provide evidence of the business use of the vehicle, and pro-rate the vehicle depreciation to that business use, accordingly.

Do not log your mileage manually with pen and paper, or with Excel. Logging mileage manually is error-prone and can be easily challenged by the tax authority in case of an audit. There are a variety of different methods to automate mileage tracking, including purchasing dedicated GPS hardware that plugs into your car or downloading a mobile application that tracks your mileage using the GPS hardware on your smartphone.

Psngr app logs mileage automatically and keeps accurate and detailed records of all the trips made, including the vehicle, driver info, the start/end odometer, route, addresses visited, and the purpose of the trip. Psngr app generates a mileage report that you can use as evidence when deducting vehicle depreciation from your taxable income.

The vehicle's recovery period

The value of depreciation in the US is calculated over a 5-year period, which is what the IRS considers a car’s useful life span. The tax deduction can be allocated over the 5-year period according to your goals and needs. This means that one person's vehicle depreciation tax deduction can be different from another person’s deduction with the exact same car and mileage.

Depreciation methods

There are two main methods for calculating vehicle depreciation under IRS guidelines: the straight-line method and the declining balance method.

  • Straight-line depreciation

Under the straight-line method, the same amount of depreciation is claimed each year for the useful life of the vehicle. This is calculated by dividing the cost of the vehicle (minus any trade-in value) by the number of years in its useful life.

For example, if you bought a vehicle for $30,000 and it has a useful life of 5 years, you could claim $6,000 in depreciation each year under the straight-line method ($30,000 / 5 years = $6,000 per year).

The straight-line method is simple and straightforward. You should use it only for depreciating a personal vehicle that you use for business and if your business use of the vehicle is less than 50%. In all other cases, for instance, if the vehicle is owned by the business or the business use is over 50%, use the MACRS method to depreciate the vehicle, as it provides greater deduction during the earlier recovery years.

  • MACRS depreciation

The declining balance method, also known as MACRS (Modified Accelerated Cost Recovery System), allows for a higher amount of depreciation in the early years of a vehicle's life and a lower amount in later years.

Under MACRS, different classes of assets have specific guidelines for determining their useful lives and depreciation rates. For example, the class of assets that includes most vehicles has a useful life of 5 years and a depreciation rate of 20% per year.

To calculate vehicle depreciation using MACRS, you first need to determine the following information:

  • The vehicle's cost basis
  • The tax year in which the vehicle was placed in service
  • The recovery period of the vehicle

Once you have this information, you can use the MACRS GDS declining balance depreciation rates published by the IRS in Publication 946 to determine the annual depreciation allowance for the vehicle.

Let's say that you purchased a vehicle for $40,000 and placed it in service in 2021. The recovery period for this type of vehicle is 5 years. Using the MACRS GDS depreciation rates, you would calculate the annual depreciation allowance as follows:

  • For the first year, the depreciation rate is 20.00% and the annual allowance is 20.00% x $40,000 = $8,000
  • For the second year, the depreciation rate is 32.00% and the annual allowance is 32.00% x $40,000 = $12,800
  • For the third year, the depreciation rate is 19.20% and the annual allowance is 19.20% x $40,000 = $7,680
  • For the fourth year, the depreciation rate is 11.52% and the annual allowance is 11.52% x $40,000 = $4,608
  • For the fifth year, the depreciation rate is 11.52% and the annual allowance is 11.52% x $40,000 = $4,608

In this example, the total depreciation allowance over the 5-year recovery period would be $39,696, which means that the vehicle would be fully depreciated by the end of the recovery period.

It's important to note that the MACRS GDS depreciation rates are only one method for calculating depreciation. There are other methods, such as the MACRS GDS 200% and 150% declining balance methods, which may be more appropriate for certain types of vehicles or businesses. It's always a good idea to consult with a tax professional to determine the best method for your situation.

Generally. MACRS is the only depreciation method that can be used by car owners to depreciate any car placed in service after 1986. However, if you used the standard mileage rate in the year you place the car in service and changed to the actual expense method in a later year and before your car is fully depreciated, you must use straight-line depreciation over the estimated remaining useful life of the car.

Depreciation on a private vehicle used for business purposes

You can only claim vehicle depreciation on a private vehicle that you use for business if the business use is 50% or more. You will need to keep track of your mileage and provide detailed records as evidence for that business use. You can use the percentage of miles you use the vehicle for business to calculate the amount of vehicle depreciation you can claim on your taxes.

To calculate your vehicle depreciation, determine the adjusted basis of your vehicle, which is the original cost of the vehicle plus any improvements you made to it, minus any accumulated depreciation you have claimed in previous years. You can then use the MACRS method to calculate the amount of vehicle depreciation you can claim for the tax year.

Remember that you can only claim vehicle depreciation on a personal vehicle if you use it for business purposes. If you only use the vehicle for personal purposes, you cannot claim any vehicle depreciation on your taxes.

Deductions of the vehicle acquired in a trade-in

The trade-in value of your old vehicle is referred to as a carryover basis. When you trade in your old vehicle for a new one, depreciate the carryover basis separately as if the trade-in did not occur. Then, depreciate any amount that exceeds the carryover basis (i.e. the "excess basis", or the additional cash paid for the new vehicle) as if it were newly placed in service property.

How to file for a deduction of vehicle depreciation?

If you are self-employed or a business, use IRS Form 4562 to figure out your deduction for depreciation.  If you are an employee and you deduct job-related vehicle expenses using either actual expenses (including depreciation) or the standard mileage rate, use IRS Form 2106.

Disclaimer

This article is not exhaustive and should not be considered tax advice. The IRS has many rules and limits for claiming vehicle depreciation, so be sure to consult with a tax professional or review the IRS guidelines before claiming vehicle depreciation on your taxes.