There may be errors in spelling, grammar, and accuracy in this machine-generated transcript.
Jeremy Wells: Social media influencers seem to love to throw out generic and unfortunately, often incorrect tax advice. One of the most consistent messages that I see over and over again is to have your business purchase a vehicle in order to [00:00:30] write off its expenses, including and especially accelerated depreciation. And a lot of times this advice is thrown out there, even for people who aren't self-employed. But that's really not the issue here. What we're going to talk about in this episode is the nuances of deducting the business use of a vehicle. It's a little bit more complicated than what a lot of the social media influencers would have you believe. It's not as easy as just buying a vehicle in the name of a business. [00:01:00] There's more to it than that. In fact, I'm going to argue that for most self-employed folks, for most small business owners, buying a vehicle in the name of your business is probably a bad idea. Really? Uh, going to break down what the law has to say about how to deduct the business use of your vehicle, and then look at a couple of scenarios and see how it plays out for the taxpayer and why. Little decisions, [00:01:30] seemingly small decisions like whether your business should buy the vehicle can have a dramatic, uh, tax effect on the, uh, business use of that vehicle. Like I say, for most small business owners, I just don't think business ownership of the vehicle makes sense a lot of the times.
Jeremy Wells: And for tax purposes, we can usually get the same effect by just keeping things the way they are. So for this episode, we're going to look at identifying the statutory and regulatory [00:02:00] provisions governing the business use of automobiles, including substantiation requirements which often get missed in some of these social media postings about business use of vehicle. Also going to look at depreciation limitations and fringe benefit rules, and really thinking about deducting the business use of a vehicle is where all of these different provisions can intersect, and can create some somewhat [00:02:30] complicated nuances that we really need to work to understand and make sure we're applying them correctly to a taxpayers or to a business owner. Specific facts and circumstances. We're also going to explain how vehicle ownership and patterns of personal and business use affect deductibility. We're also going to look at, uh, how that affects depreciation as well. We're going to look at the listed property and luxury automobile limitation [00:03:00] rules to determine allowable deductions and depreciation for business vehicles. And we're going to look at the tax consequences of changes in business use percentage over time. This is really probably the most important aspect of deducting the business use of a vehicle to understand not just for the first year, but for every subsequent year, that that vehicle is going to be used [00:03:30] in the business. So let's jump into the authority here.
Jeremy Wells: What does tax law say about deducting the business use of a vehicle? First of all, we always start in general whenever we're talking about business deductions, we start with code section 162 I or C 162 tells us that a taxpayer can deduct the ordinary and necessary operating expenses [00:04:00] of a business. Now there's a lot of nuance to what ordinary and necessary means. And depending on different kinds of expenses, there might be some rules, some limitations, specifically when it comes to business use of an automobile. Uh, there is an allowance for operating expenses of automobiles used in a trade or business. Section 162 doesn't say anything [00:04:30] about the ownership of the vehicle, about the business use of the vehicle. What it says is that the operating expenses of an automobile used in a trade or business can be a deductible business expense. However, whenever we look at deducting a expense under section 162, we also have to look at IRC section two. 62. Two. 62. Is essentially the mirror image of section one. [00:05:00] 62. Section one. 62. Tells us that business expenses that are ordinary and necessary are deductible. Section two. 62. Tells us that personal living or family expenses are not deductible, and that includes commutes between the taxpayer's residence and the taxpayer's place of business or employment. That quote directly comes from revenue ruling 997. Revenue ruling 997 [00:05:30] is important when it comes to thinking about the deductibility of a business use of a vehicle.
Jeremy Wells: It clearly lays out the difference between a business trip and a personal trip. And this is the unit of analysis when it comes to thinking about whether a The use of a vehicle is for business purposes and therefore deductible or [00:06:00] not. I'm going to talk about this a little bit more here in a minute. But we need to think about whether a vehicle is used for each specific trip for business or a personal commute. We're going to talk about that more a little bit in a little bit, but keep that in mind the entire time that we're thinking about whether the use of a vehicle is deductible or not, we're essentially trying to [00:06:30] frame as much of the discussion as possible between whether that use is an ordinary and necessary business expense, and therefore would qualify as deductible under section 162, or whether the use of that vehicle is personal in nature and therefore is not deductible under section 262. Now, obviously, if we're advocating on behalf of the taxpayer, if we are the taxpayer, we want to try to treat as much of the use of that [00:07:00] vehicle as business and deductible as possible. But we have to be aware of the rules and regulations that tell us that actually, some of that use is probably not going to be business even if we think it is. And as I said, that term commute is where a lot of taxpayers get in trouble.
Jeremy Wells: So when it comes to deductible trips, we [00:07:30] can look at trips that are from the taxpayer's main workplace and another workplace in the same area. When we talk about trips, it's helpful to think about those trips as having an origin and a destination. And the trip itself is defined by both of those points. So when we're looking at deductible trips, if both the origin [00:08:00] and the destination are business locations, then the trip between them is a business trip and is therefore deductible. So one example of this is traveling from the main workplace to another workplace in the same area. What might that look like? If you are at your main office and you travel, you drive your vehicle to go meet a customer at [00:08:30] the customer's location. And when you get to that destination, you meet with the customer, you legitimately discuss business with them. Maybe you make a delivery, maybe you help advise them to some sort of business decision. This is not just idle chit chat. This is not a personal meeting. This is an actual business meeting. Then in that case, both the origin and the destination of that trip are [00:09:00] business related, and therefore the trip between them is a business trip. Visiting customers in the local area of the taxpayer's workplace is another example. Attending an off site business meeting in the local area of the taxpayer's main workplace. So for example, if you have a networking group that you meet up with and so you start at your office, your your main place of work, and then you meet [00:09:30] up at a coffee shop or at a restaurant, or maybe the local library, and you have a room reserved where a few of your colleagues, some people that you network with other business owners and you get together with them.
Jeremy Wells: That is a business meeting that is in your local area. And so both the origin and the destination of that trip have business purposes and therefore the trip between them. Then also going between [00:10:00] the taxpayer's residence and a temporary work location outside the metro area where the taxpayer lives and normally works. And this is, uh, not quite as relevant in today's world. A lot of these kinds of trips we would probably do remotely, we would do video calls or even phone calls. But if you're going to meet someone, if you're driving to meet [00:10:30] someone outside your metropolitan area at a temporary work location, this is the one exception where that trip beginning with your residence can actually be a business trip. So this is not you driving to your office. This is not even you driving to a local destination where you're meeting up with other business owners. Instead, you're driving to a temporary work location outside your metro area. These rules were [00:11:00] developed before we had the suspension of the itemized deductions that allowed employees to deduct the unreimbursed business expenses that they had as employees.
Jeremy Wells: And what would happen is workers would be assigned to temporary work locations, especially in fields like construction and the fields around [00:11:30] that, where you didn't always go to the same work location every day, every week, every month, you might have a different site that you needed to go to. And so driving to that different site, even though you're commuting to work, it's not your normal work location. And as long as it's temporary, meaning you expect to have your job at that location for less than a year. That made that a business trip and therefore deductible. It still carries on as [00:12:00] a deductible trip for business owners today. We'll talk about employees later on and how they might be able to get a tax benefit from using their personal vehicles in these kinds of work related situations. But if your trip both begins and ends with a business focused location, then that trip between them is deductible. [00:12:30] On the other hand, if one of those two points is not business related, if you either start from your personal residence or you end at your personal residence, then that trip is by definition a commute, which is a personal trip and it's not deductible. This is where a lot of my small business clients run into problems, because they might be tracking the mileage of the vehicles that they're driving [00:13:00] for work.
Jeremy Wells: And when I'm looking through their mileage logs that they give me at the end of the year so I can start working on their tax returns, I filter that mileage log in a in a spreadsheet, I filter that log for the personal residence of that client. So I'm going to see if any of those origins and destinations for those trips are my client's personal residence. [00:13:30] And nine times out of ten, a lot of those trips begin or end with the taxpayer's personal residence. By definition, that makes those trips a commute and therefore nondeductible. And so the mileage log might have told that individual that they had a lot of business miles, and therefore they were expecting a pretty big deduction. Unfortunately, a lot of those trips may not qualify. So it's important when you're reviewing those mileage logs [00:14:00] to filter out those trips that don't qualify as actual business trips. The exception there, of course, is if it's a drive to a temporary work location outside the taxpayer's metro area. But if it's a local trip, then that trip has to both begin and end with a business location. There's a way to make this work in the taxpayer's favor. However, [00:14:30] generally, trips that begin or end with the taxpayer's residence are nondeductible commutes. However, the Tax Court found that going between a bona fide home office and other work Locations were deductible. In other words, that home office, if it qualifies under section 280 cap a C1A.
Jeremy Wells: That's the part of the tax code that deals with your [00:15:00] personal residence. And what of that personal residence is deductible or not? That specific paragraph, section 280 cap a C1A is essentially the Home Office deduction. And if your home office is a qualifying home office, you actually take a home office deduction on your return, then that qualifies the origin of your trips that start with your residence as a business [00:15:30] location. You don't have a separate office, you have a home office, and that is your principal place of doing business. So therefore, when you leave your personal residence, you're also leaving your primary place of business. And in Kirfi, the commissioner. That's 73. Tax court seven. 66 is is from 1980. The Tax Court held that that makes that trip a deductible business trip. And IRS, uh, [00:16:00] pulled this tax court ruling forward in its revenue ruling 997, essentially emphasizing, uh, this fact that if you have your home office, the trips that begin or end with your personal residence become essentially business trips. Now, it's important to keep in mind, though, that commuting still remains a personal expense. And this is a topic [00:16:30] that has actually made its way all the way to the US Supreme Court. There are a few different US Supreme Court cases that, uh, look at this question of whether a trip is a deductible business trip or commute when it begins with the taxpayer's residence and flowers.
Jeremy Wells: V Commissioner. 326 US 465. This is a 1946 Supreme Court ruling. The court held that an [00:17:00] attorney who had been hired by a railroad as its general counsel could not deduct his trips between Jackson, Mississippi, his home and the corporate headquarters in mobile business trips. The court concluded, are to be identified in relation to the business demands and the travelers business headquarters. The exigencies of business travel, rather than [00:17:30] the personal conveniences and necessities of the traveler, must be the motivating factors. In other words, it has to be necessary and ordinary. We're still talking about a section 162 ordinary and necessary business expense here. If the taxpayer just chooses to have an office in one town and live in a different town, that doesn't make the trip between them a deductible business trip, it [00:18:00] still remains a commute. It's also important to keep in mind that when we say that your personal residence has a home office, and therefore that makes that the, uh, the origin or the destination, if it begins with your residence, a deductible business trip, you can't just say, well, I have a home office, I have a desk and my computer is set up there. It needs to be a bona fide home office. And there are rules associated [00:18:30] with section 280 cap A that give the requirements for what it takes to be a home office. In other words, it's not a home office just because you say it's a home office, It's a home office because it's your primary place of working.
Jeremy Wells: So if you have that, that makes your personal residence a, an origin or a destination with a business purpose. And therefore, if the other location in that trip is also a business purpose, [00:19:00] that makes it a deductible business trip, but that may not be the case if you don't actually have a qualifying home office. Whenever we talk about the business use of a vehicle, in fact, whenever we talk about any kind of business travel. So whether you're doing that in a vehicle or by plane or train, we have to worry about the substantiation rules that come from IRC section 274 specifically. 274 [00:19:30] D deducting travel expenses under IRC section 162, meaning we're deducting them as ordinary and necessary business expenses and any expenses with respect to listed property under section 280 cap F, and we'll talk about 280 cap F in a minute. That includes any passenger, automobile or any other property used as a means of transportation. Any deduction associated [00:20:00] with that kind of activity requires strict substantiation. What does that mean? The taxpayer has to substantiate the expenses by adequate records or by sufficient evidence corroborating the taxpayer's own statement. And that has to include the following the amount of the expense, the time and place of the travel and the business purpose of the expense. [00:20:30]
Jeremy Wells: So it's not enough just to say that I made these trips and they were for business, and therefore I get to deduct the amount you have to be able to show to demonstrate to someone who's not familiar with you or your business. You have to show them at least enough evidence to convince them that what you're claiming as a necessary transportation or travel [00:21:00] expense is legitimate. The best way to do that is with a written contemporaneous log. The way I encourage my clients to do this is to use a smartphone app. Uh, there are a few out there. One of the ones that I usually recommend is one called mile IQ. There are a couple of other apps out there. In fact, [00:21:30] some of the bookkeeping softwares I know QuickBooks online does. This will track mileage inside of that app as well. But it's whether it's, it's a digital or actually written down in a notebook or some other way kept in a spreadsheet of tracking each individual trip along with the date, the mileage, and the business purpose of that trip. That is all [00:22:00] necessary in order to be able to substantiate the related expense. Now, the 274 regulations require either adequate records or if the records are not adequate, then sufficient evidence to substantiate those expenses under section 274 D. This comes from regulation section 1.2745 T. That [00:22:30] T means it's temporary. This particular regulation 1.2745 T has been temporary for a few decades now.
Jeremy Wells: Just because it's marked as a temporary regulation doesn't mean that it doesn't count. It's still what we rely on when it comes to the substantiation rules. And here we get the definition of what we mean by adequate records and sufficient evidence. Adequate records is what we hope [00:23:00] to have. It's what the taxpayer should be striving for in order to substantiate those expenses. Adequate records means an account, book, log, diary, or statement of expense and documentary evidence. So it's the combination of both. We have that written log or book or diary, along with documentary evidence such as receipts or [00:23:30] bills. If we can put those two together, then that is adequate records. Now, the term itself doesn't seem like it sets that high of a bar. We're not saying that the records have to be great. We're not saying that they have to be fancy. We're just saying they have to be adequate. If we can have that log or statement or diary and combine that with documentary evidence, then we have adequate records. These [00:24:00] have to be prepared contemporaneously or near the time of the expense. So it doesn't have to be exactly when the expense happens, but it does need to be relatively soon after that expense occurs. It also needs to be detailed enough to establish those required elements that I listed before, the amount, the time and place, and the business purpose.
Jeremy Wells: In the absence of adequate records. So in the case that the taxpayer [00:24:30] can't provide a contemporaneous log or documentary evidence, meaning receipts or bills. Then the standard is sufficient evidence, which means that the taxpayer gives a statement of what the taxpayer claims happened, plus some corroborating evidence. And this is when the taxpayer fails to meet the adequate records standard. So [00:25:00] if the taxpayer can't come up with adequate records, then we look at whether the taxpayer has sufficient evidence. Is the taxpayer claiming and making a statement of some amount of expense? And then is there anything the taxpayer can show to corroborate that that is less than an actual receipt or a bill? One of the kinds of evidence that might that a taxpayer might try to provide in a situation like this [00:25:30] would be bank statements. So the taxpayer can't show actual receipts doesn't have the receipts to show what was paid, but maybe the bank statements show the transaction. So in terms of vehicle usage, you could show that charges were made for fuel, for maintenance. And maybe from the bank statements, you could determine the location of where those expenses were paid. And based on when those charges occurred, you could [00:26:00] show the date of when they occurred and you would have the amount as well. So you're not proving that there was an actual business purpose. You're not even really proving exactly when and where those expenses occurred, but it would give you some support on which to base the assessment of the claim that the taxpayer is making.
Jeremy Wells: Again, this is if the taxpayer fails to demonstrate actual adequate records [00:26:30] for the adequate records test contemporaneously kept records are always going to have greater weight than reconstructed records. There are tax court cases. There are lots of tax court cases where the IRS challenged the deductibility of claimed vehicle related expenses from taxpayers, and when pressed to provide a log to meet this adequate records test, the taxpayer [00:27:00] would provide, uh, something constructed after the fact from memory. This is true in some other similar cases. For example, those having to deal with material participation for rental properties is where we see this in tax court pretty often, where the taxpayer will from memory try to recreate that log. It's not based on actual contemporaneous records. It's based on an after the fact recall of what may or may not have [00:27:30] happened. And usually the IRS and the courts will see right through this. Uh, it's not necessarily bad, but it's also not nearly as helpful as a lot of taxpayers think it will be. Because if you have a record that you can demonstrate was kept in the moment, again, this is why I usually recommend a smartphone application. It's tracking all of that happening in real time. If you've never used one of these applications before, it's on your phone. If your phone's [00:28:00] in your pocket or it's in the car with you, as soon as your phone's GPS recognizes that you're moving faster than a normal human being can walk or run, it assumes that that is a trip in a vehicle, and it will make a log of that trip.
Jeremy Wells: It will track when that trip begins, where and when it ends, and then you'll have the opportunity later on to go back and add some notes and to classify that trip [00:28:30] as either business or personal. That is a contemporaneous log of your trips. It's digital. It's kept in the cloud usually, and so you don't have to worry about losing the notebook or, uh, you know, getting destroyed somehow. You have that record and usually you can log into a website or you can just manage the app there on your device and you've got that log taken care of. It makes it relatively easy to keep up with that. That is [00:29:00] essentially the gold standard. If you can have that and keep up with that, then you're in the best possible situation that you could be in when it comes to substantiating your business vehicle expenses. Otherwise, if you don't have that and you're trying to replicate that log from memory, or you're relying on some sort of corroborating evidence to support your claim of those trips, you're going to have some more [00:29:30] scrutiny. As far as your story, you're going to have to try to pull from some different sources in order to back up what you're claiming.
Jeremy Wells: A lot of times, taxpayers will rely on odometer readings that have been recorded by a third party. This often happens when you get the oil changed on your car or take it in for a service, uh, visit. So a lot of times taxpayers that need to track their mileage will get an oil change [00:30:00] on January 2nd or third as quickly after the new year as possible. This essentially establishes the odometer reading as of the end of the prior year. And so if you've got two oil changes, January 2nd of last year, January 2nd of this year, you can at least establish by, you know, some third party reading your odometer, you can establish what your total mileage for the year was. And then you can try to back into [00:30:30] a claim of how much of that was your business mileage. It's not necessarily going to work all the time, but it can be more helpful than just nothing. It's important to keep in mind if you've heard of the Cohen Cohen rule, that strict substantiation supersedes that rule. So strict substantiation rules of 274 D, which is what we're talking about here. Those supersede the Cohen rule, which allows courts to estimate expenses in the absence [00:31:00] of taxpayer records. Without adequate taxpayer records, a court cannot use an approximation or unsupported testimony of the taxpayer to estimate travel expenses, including operating costs and depreciation that comes from regulation.
Jeremy Wells: Section 1.2 745TA4 when it comes to vehicle use. Congress has effectively Eliminated. Judicial mercy. Right. [00:31:30] Listen to episode 13 of this show, The Legal Case for Better Books. In that episode, I discussed the Cohan rule and some cases where it doesn't apply. If you haven't listened to that episode, finish this one and then go back and listen to episode 13. One of the points that often gets missed in this discussion of whether the business should own the vehicle or not is that when a business or employer owns a vehicle that's used [00:32:00] by an employee, and this is going to include an S corporation shareholder who is an employee of that business by virtue of being a corporate officer, the business use of that vehicle is a nontaxable working condition, fringe benefit, the business use of that vehicle. So if my business owns a vehicle and I use that vehicle purely for business purposes, I use it just to go meet clients or to make deliveries, then that is a nontaxable fringe [00:32:30] benefit. The business gets to deduct the operating cost of that vehicle. I don't have to include anything in my gross income or my wages. Nothing shows up in my payroll. However, any personal use of that vehicle, including those nondeductible commutes, is included in my wages as taxable compensation. Commuting is personal use, even if the vehicle is otherwise used for business.
Jeremy Wells: This is IRC section 274 L. [00:33:00] It's also regulation section 1.6121. Irc section 61 is all about what's included in gross income. So that specific regulation 1.6121 is about when fringe benefits are included in compensation, specifically with respect to vehicle expenses. If the business owns the vehicle and I use that vehicle for personal purposes. That is part of my compensation [00:33:30] from that business that increases my gross wages, which means it also increases the payroll tax in my taxable income. If the vehicle is instead owned by me personally, and I use it for business purposes because my employer told me to, then it's possible to get a reimbursement that is deductible for the business, but tax free for [00:34:00] me. Under what's called an accountable plan, an employer can provide tax free, deductible reimbursements to employees for expenses paid or incurred by the employee in connection with the performance of services as an employee. And this includes the business use of my personal vehicle for a discussion of both Uh, transportation as a fringe benefit and accountable plans. Go back and listen to episode [00:34:30] 19 of this show. Tax free Employee benefits part three. I go into the details of what is and is not considered tax free fringe benefits with respect to transportation, as well as how accountable plans work. It's important to note that the one big, beautiful Bill act ob A, made permanent the suspension of Unreimbursed employee expenses by the Tax Cuts and Jobs Act of 2017.
Jeremy Wells: This [00:35:00] means that an employees only tax advantaged recourse for business expenses paid out of pocket is reimbursement through an accountable plan. So if you are an employee and you use your personal vehicle for business purposes, the only way you're going to get, uh, some sort of recourse for that is by being reimbursed by your employee, by [00:35:30] your employer, excuse me, under an accountable plan. And that accountable plan needs to be qualifying under regulation section 622. If it's not, then that reimbursement comes to you as taxable income. So you've had you've incurred the expense and you've increased your taxable income. If you work for an employer and you're not getting reimbursements for the business use of your personal vehicle or any of your other [00:36:00] personal assets, such as your home office, ask your employer about setting up an accountable plan to get those reimbursements. We also need to be aware of the depreciation limits for most passenger automobiles. I mentioned earlier code section 280 cap F. This code section limits the annual depreciation expense for listed property and listed property includes, among a few other things, [00:36:30] passenger automobiles. Now the limit is annually inflation adjusted. So every year IRS puts out a notice of what the next year's depreciation limitation is going to be for vehicles. For this purpose, a passenger automobile means any four wheeled vehicle manufactured primarily for use on public streets, roads and highways is rated at 6,000 [00:37:00] pounds or less of unloaded gross vehicle weight that does not include ambulances, hearses used in a trade or business, any vehicle used directly in a trade or business of transporting people or property for hire, and a truck or van that is a qualified non personal use vehicle as defined under regulation section 1.2745 K.
Jeremy Wells: Now [00:37:30] that's a little bit complicated. Essentially, if it's a normal vehicle that you'd expect to see out on the highway, that isn't a special use vehicle and that is not in excess of that 600 0 pound unloaded gross vehicle weight, then it's a passenger automobile for purposes of section 280 cap F. So that section that I mentioned, 1.2745 K, it lists specific vehicles that, you know, no, no one would consider [00:38:00] passenger as a passenger vehicle. Um, clearly marked first responder vehicles, cement mixers, cranes, dump trucks, garbage trucks, those kinds of things. Those wouldn't count as passenger vehicles for this, uh, for this purpose. The depreciation is limited to the business use percentage as well. This comes from section 280 cap FD2. A taxpayer can only deduct the portion of depreciation applicable to qualified [00:38:30] business use. Back to substantiating the business use of that vehicle. If the taxpayer has a mileage log, and that mileage log shows that the business use of that personally owned vehicle is a certain percentage, then the maximum depreciation is limited to that percentage of the maximum depreciation expense for that tax year.
Jeremy Wells: Any portion of the depreciation applicable to personal [00:39:00] use or non-business use can't be deducted. However, the taxpayer reduces her basis of the property by the entire amount of depreciation, including that personal amount. For purposes of determining the unrecovered basis to be used for future depreciation calculations. So let's assume that the maximum depreciation for that vehicle for the year would be $5,000. But [00:39:30] the business use that vehicle was just 60%. That means 60% of 5000 or $3000 is the deductible depreciation expense for that vehicle for the year. However, the basis of the vehicle would still be reduced by the full $5,000. And then that is the adjusted basis that would be used to calculate any future depreciation and then any gain or loss on the sale of that vehicle. Normal [00:40:00] depreciation rules apply if the business use of the vehicle is more than 50% by normal depreciation rules, I mean those rules under IRC section 168. Those rules will all apply if the business use of the vehicle exceeds 50%. With that limitation, we just discussed of only the depreciation applicable to the business [00:40:30] use of that vehicle can actually be deducted. However, if business use drops below 50% during any subsequent tax year, then the taxpayer has to change the depreciation of that property from the normal section 168 depreciation method, which is usually the modified adjusted cost recovery system, or Macrs, has [00:41:00] to change from makers to section 168 G.
Jeremy Wells: Alternative depreciation system or Aids Aids is straight line, whereas Macrs is double declining balance usually. And the Aids usually has longer class lives than makers does. So if the business use of the vehicle drops below 50%, then the taxpayer is usually in a worse position when it comes to taking any future depreciation. [00:41:30] But here's the real kicker. Not only that, but because the taxpayer had to change to a different depreciation method, then at the same time, the taxpayer has to recapture as ordinary income any excess depreciation, meaning the amount of depreciation taken, including any section 179 deduction and one section 168 K special depreciation allowance or bonus depreciation less the amount of depreciation allowable. [00:42:00] Had it not been used more than 50% in the year it was placed in service. So in other words what should have been the depreciation under that alternative depreciation system which will be relatively a lot less than what it was under makers and therefore what's the excess That's depreciation taken, and that amount has to be recaptured by the taxpayer as ordinary income when it comes to vehicles. Accelerated depreciation and especially section 179 expensing are wagers [00:42:30] on future business use. When you take accelerated depreciation and section 179 expensing on a vehicle that's subject to the rules under section 280 cap F, you're essentially gambling that the business use that vehicle will never drop below 50%. That's that's a pretty tough gamble.
Jeremy Wells: And for a lot of my clients, I'm usually not willing to make that. Campbell. [00:43:00] I've seen cases and I've heard of too many cases where business use drop below 50% for various reasons. And so it's important to keep that in mind and to, if you're working with taxpayers to advise them of the possible repercussions. It's also important to remind them of that year over year, especially if you're getting the mileage logs. If you're seeing the change in business use year over [00:43:30] year. It's important to remind them, especially if you see a decline in business use year over year. It's important to remind them of what could happen if business use falls below 50% at any point in a tax year. They're facing changing depreciation method as well as having to recapture that excess depreciation. Now there is a much simpler alternative to all this. Treasury regulations permit the IRS to establish alternative substantiation rules for [00:44:00] certain expenses, including mileage allowances for transportation to, from and at the destination while traveling away from home. Essentially means what we're talking about, uh, vehicle expenses. Certain taxpayers can use the standard mileage rate published annually by the IRS to substantiate the amount of a deduction to compute adjusted gross income for an automobile that a taxpayer either owns or leases. Standard mileage rate is available both for [00:44:30] owned and leased vehicles. The taxpayer can then take that standard mileage rate, multiply it by the number of miles, and treat that as the deductible amount for auto expense or vehicle expense.
Jeremy Wells: And in addition to that, parking tolls, automobile loan interest and state and local personal property taxes are not included in that standard mileage rate. So [00:45:00] those expenses are separately deductible from the standard mileage rate. But all of the other operating expenses, including repairs, maintenance, fuel, tires, insurance, those sorts of expenses. Those are all captured by that standard mileage rate. So they're not separately deductible. So when it comes to thinking about all this, this is a lot of different things that all kind of overlap when it comes to thinking about whether the [00:45:30] use of a vehicle for business is deductible or not. We've got multiple different code sections, multiple different sets of regulations, multiple sets of guidance from IRS. We've got court rulings. There's a lot going on here. This is what I started off this episode saying. It's a much more complicated and nuanced topic than what a lot of the advice online would lead you to believe. So how do we simplify this down? I use a three question framework to really get at the heart of [00:46:00] what's happening. Whenever it comes to thinking about deducting the business use of a vehicle. The three questions are who owns the vehicle, who uses the vehicle, and then what percentage of the use of that vehicle is for business? And really, when I'm talking about the percentage of use of the business, I'm not just looking at the individual tax year.
Jeremy Wells: I'm also looking at how that's expected to change over time. In [00:46:30] my experience, most of the mistakes and most of the complex situations arise when at least one of these three questions, or the answer to one of these three questions, was ignored or not taken into account. Ownership determines who or what is going to take the deduction and therefore how it should be reported. Usage determines whether trips are deductible for the owner or compensation [00:47:00] for the user. And again, that's going to relate to ownership. Really ownership and usage have a pretty strong interaction there. But then percentage of use is going to determine whether those limitations apply and whether you can wind up in certain situations like recapture under section 280 cap F that I've mentioned. Now for purposes of this framework, ownership includes leasing. So leasing is really just an alternative [00:47:30] way from this perspective of owning for tax purposes. It doesn't change who owns the vehicle in terms of the analysis. All it changes is whether the owner can depreciate the vehicle or not. But in terms of answering the three questions, ownership and leasing are essentially the same thing. So let's look at some examples to think about how we might apply this framework. So Jessica solely owns lighthouse LLC, [00:48:00] which she reports on schedule C with her form 1040. She mainly uses her personal vehicle to meet customers and make deliveries.
Jeremy Wells: She occasionally uses it for personal errands and trips Based on her trip log, 80% of the use is for business purposes, but they all begin or end with her residence, and she heard from a friend that she could purchase a new vehicle in 2026 with her LLC and claim accelerated depreciation. Let's break this down using the framework. The ownership [00:48:30] of the vehicle is currently personal, but she's asking about business ownership and whether that makes sense or not. Her usage is primarily business with some personal use, and then the percentage use is relatively high at 80%, but only if she also has a bona fide home office. Note that most of those trips in her log begin or end with her residence. That should trigger a question. [00:49:00] If you're a tax professional working with Jessica and you're her tax preparer is her personal residence Also where she primarily works and does. She has a home office there. So the question here that she's asking is, would a change in the ownership from her to her LLC affect the tax treatment of her vehicle? And really, the answer is no, it wouldn't. Her LLC is a disregarded entity. So for tax purposes, it makes [00:49:30] no difference. She's going to deduct the expenses related to the operation of this vehicle the same exact way, whether she owns it or her LLC owns it. Changing the title isn't going to change the tax treatment.
Jeremy Wells: All the expenses that she could deduct now are going to be the exact same expenses that she could deduct, whether her business owns the vehicle. However, I will say, and this is a non-tax concern that tax professionals should be aware of as well as small business owners. Usually what [00:50:00] I've seen is that when clients try to purchase vehicles through their businesses, they generally face higher financing costs, especially in terms of the interest rate as well as higher insurance costs. And so generally, taxpayers wind up paying more in terms of operating costs to have a vehicle owned by the business when for tax purposes, they don't get any more write offs than they would have. And so they wind up paying more for no additional [00:50:30] tax benefits. So what's the main concern here in this case? It's not the ownership of the vehicle. It's whether she has that bona fide home office that's going to determine whether she can claim most of those trips as deductible business trips or not. So Jessica is getting wooed by some, uh, you know, friend telling her that she needs to buy the vehicle with her LLC and that that will get her all these deductions when [00:51:00] really the issue couldn't be further from that. It's really has to do with whether those trips are deductible or not. And that's going to depend on whether she has a home office or not.
Jeremy Wells: Now let's look at a similar situation instead. Now, instead of lighthouse LLC being a sole proprietorship, now let's make it an S corporation. And does this change anything? So again, she mainly uses her personal vehicle to meet customers and make deliveries. Based on the trip log, it's [00:51:30] 80% business use. The corporation reimburses her for the business use of her home office via an accountable plan. So now she has a bona fide home office, and her S corporation is reimbursing her for the cost of that home office. Again, she heard from a friend that she should purchase the vehicle in her business and claim accelerated depreciation. So the ownership is the same. It's still her personally owning the vehicle. The usage is [00:52:00] still the same. It's still primarily business use with some personal use and the percentage use. Well, now that we know she has a bona fide home office. We've confirmed that it's roughly 80%. So would a change in ownership from her to her LLC affect the tax treatment of her vehicle in this situation? And it absolutely would, because she is no longer a sole proprietor. She is an officer and an employee of the S Corporation. So if she [00:52:30] has a vehicle that is owned by her corporation and she uses it personally, that personal use of that vehicle becomes taxable compensation to her. And this is why asking about usage matters, even for a business owned vehicle, a much simpler approach in this situation would be to reimburse her for the mileage or for the business portion of her actual operating [00:53:00] expenses.
Jeremy Wells: Under an accountable plan, she already has the accountable plan reimbursing her for the Home Office. Adding an accountable plan to cover her vehicle expenses as well would solve the problem would make the business use of her vehicle deductible without introducing any additional complexity into her situation. Now let's look at a similar situation. But in this case, she uses her business owned [00:53:30] vehicle. The LLC actually owns the vehicle now to meet customers and make deliveries. She only occasionally uses it for personal errands and trips, but based on last year's trip log, 60% of the use is for business purposes, and that's a decline from 80% the year before. She says her online sales have grown recently, so she doesn't drive as much to meet customers or make deliveries, and she's expecting less than half of her sales will be [00:54:00] local in the coming year. So again, let's break this down. The ownership now is business. The usage is primarily business, but there's some personal use here. And actually that personal use relative to business use is increasing. Her business use is declining and it's on pace to drop below 50%. So knowing that, how would we advise Jessica? What should Jessica do? Well, she has some options here. She can either [00:54:30] prepare for recapture by projecting out the tax effect of that recapture and changing to a different depreciation system, and then make estimated payments to cover that tax.
Jeremy Wells: Now, that's probably the least desirable option available to her. What she could also do is increase the business use percentage, either by reducing the personal use to keep it above 50%, or just increase the amount of business trips she's making in that vehicle. Now, [00:55:00] she can't artificially do that. She has to make legitimate business trips, but the way she can increase the percentage and keep that above 50% is to stop making so many personal trips in the vehicle. That might mean getting another personal vehicle. It might mean using public transportation or a bicycle more, but she's going to have to figure out a way if she wants to do this option, if she wants to avoid recapture, to increase the business use percentage by reducing the personal use of the vehicle. [00:55:30] Or a third option is if business use hasn't declined below 50% yet, if she's still above 50% with this vehicle, she could either distribute the vehicle to herself and get it out of the business's ownership, or just sell it from the business. That's another option as well. But once business use drops below 50%, that recapture is unavoidable. So it's really important to keep that in mind. All right. So this has [00:56:00] been a pretty high level overview of business use of vehicles, but I hope you can see that there are some important nuances here and quite a bit of complexity to keep in mind as we're thinking about deducting business use of vehicle.
Jeremy Wells: So what are some takeaways here? The best tax treatment of a vehicle can usually be determined by knowing those three key facts the ownership, the usage, and the percentage of business use. Knowing those three things is really critical to [00:56:30] understanding the tax treatment of the business. Use of a vehicle. Accelerated depreciation is a benefit if the business use is and will remain consistently high. Otherwise, recapture can be costly, and accounting for that personal use of a business owned vehicle can get pretty expensive. And really, depending on the tax entity type of the business. Business ownership of the vehicle may not even be necessary to [00:57:00] get that depreciation and then personal use of a business owned vehicle is taxable. We have to keep that in mind. Having your business own your vehicle probably won't make sense except under certain conditions. In fact, doing so will probably cause you a lot more expensive headaches and complexity than necessary. The best vehicle strategy is not the one that maximizes this year's deduction. It's the one you can defend [00:57:30] three years from now. It's the one that still makes tax sense three years from now. If you found value in this episode, please let me know by leaving a comment and liking in your podcast application of choice or on YouTube. And for the next episode, we're going to look at three key figures that you need to know in your S corporation.