Simplified Auto Expense Deduction Rules for the Frugal Entrepreneur in 2023

Don’t be afraid to take the auto expense deductions the law allows, even if the IRS scares the bejesus out of you!

I’ve been self-employed for close to 35 years and one of the first things I learned were the rules for auto expense deductions (gotta learn how to deduct that Dream Porsche!  Damn The Tax Reform Act of 86!).

The aforementioned Tax Reform Act of 1986 (referred as TRA86) started the higher scrutiny on what is and what is not deductible in regards to automobiles. This is our starting point with defining the auto expense deduction rules that will give you the biggest deduction.

1986 introduced the concept of a Luxury Vehicle (anything that cost more than $25k if you can believe it) and the rules for deducting high priced cars.

We’ll also learn about leases and how they are accounted for with a weird little twist at the end.

This article will provide a comprehensive look at auto expense deduction rules for self-employed individuals in 2023.

We’ll cover eligibility, types of deductible expenses, calculation methods, special considerations, record-keeping and reimbursements.

What Are The Rules for Auto Expense Deductions?

Obviously you need to be self-employed and use your car for business purposes. The vehicle can be either used exclusively for business (think like a plumbers van full of knobs and hoses and toilet stuff) or used for both personal AND business purposes (my Porsche which I might take a Sunday drive with). There is no deduction allowed unless there is a business purpose.  Personal vehicles expenses aren’t deductible other than part of the annual state registration.

What Auto Expenses Are Deductible?

Track all expenses.  Gas, oil changes, car washes, repairs and maintenence, registration, parking and tolls, monthly payments…

Track it all.  You may not be able to write it all off, but you might be able to get a bigger deduction if you do.

If you purchased the car, you can write off the interest (not the entire payment) and take depreciation.  If you are leasing the car, you can take the entire lease payment, but you’ll have to add back a “Lease Inclusion” amount based on the fair market value of the vehicle.  Leases will be explained in more detail in the next section.

Leases and why they exist

Leasing a car as a business decision can be a good thing.  A lot of people use them to “have” a nicer car than they can afford.  You’re basically renting a car long term.

This example will be for a vehicle less than 6,000 lbs GVWR (Gross Vehicle Weight Rating).  Vehicles with a GVWR over 6,000 lbs are treated differently.  I’ll discuss this a little later on in the article.

Leasing For a Business?

But leases for a business are another story.  When you purchase a car you are able to depreciate that vehicle over 5 plus years.

When you lease a car, you get to deduct the lease payments less a small amount called the Lease Inclusion.  The IRS publishes tables showing how much you must add back, based on the FMV of the vehicle.

This usually results in a larger auto expense deduction than depreciation.  But the cost of leasing the car is generally more than if you buy.

Let’s pretend you are buying a delivery van with a retail price of $50k.  At 8% over 5 years, your loan payment will be around $1,000.  If you were to lease that same van, your lease payment would be a lot less, say $650 a month.

On the surface, this looks like a great deal.  $650 is a lot less than $1,000.  But what are you getting?

At the end of the lease, you have the option of buying the car (or what’s called the residual value, which was established when you initially leased the car.  This is generally around 50-60% of the original asking price,  So after leasing the car for 48 months (I usually recommend no more than 36 month terms), you can buy it for $25-30k.

You’ve paid $31,200, the car is 4 years older and they want you to pay $30k to keep the car.  From a financial perspective, this is a lousy deal.

As a business owner, the ability to deduct the actual lease payments generally gives you a better deduction, even when taking depreciation into consideration.  It would be to your advantage to do a buy or lease comparison prior to plunking down your hard earned cash.

Vehicles with an over 6,000 lb GVWR

This is only an issue if you purchase the car (not lease).

If a vehicle has a GVWR of over 6,000 lbs its generally a large or midsize SUV or truck.  A vehicle with a 6,000 GVWR is treated differently and has the ability to deduct much more than vehicles with a GVWR under 6,000.

Vehicles above the 6,000 lb limit have the ability to take more depreciation via Section 179 or Bonus Depreciation rules for 2023.  For 2023 the max section 179 deduction allowed is $28,900.  Under the 6,000 lb threshold, the maximum depreciation you can take the first year is $20,200 (including $8,000 in bonus depreciation).

Calculation Methods for Auto Expense Deductions

Self-employed individuals have two primary methods for calculating auto expense deductions:

• Standard Mileage Rate Method:
  • The IRS sets a standard mileage rate for each tax year. For 2023, the standard mileage rate is 65.5 cents per mile (this can change mid year like it did in 2022).
  • Self-employed individuals can deduct the business-related mileage by multiplying the total business miles driven during the year by the standard mileage rate.
• Actual Expense Method:
  • Under this method, self-employed individuals can deduct the actual expenses incurred for the business use of the vehicle. This includes fuel, repairs, maintenance, insurance, depreciation, and other eligible expenses.
  • To use the actual expense method, detailed records of all vehicle-related expenses must be maintained.

Choosing Between Standard Mileage Rate and Actual Expense Method

Miles?  Or actual costs?  Which is higher?

The mileage rate for 2023 is $ .655 per mile.  Drive 20,000 miles for business and you get a $13,100 mileage deduction.

But what were your actual costs?  Repairs, insurance, registration, gas and oil.  Depreciation?  Which is higher?  Doesn’t matter.  Whichever gives you the biggest deduction is the one you get.

The one thing to be aware of, if you do want the option to switch between mileage and actual cost, you must use mileage the first year you use the car for business.

Special Considerations for Luxury Vehicles

Luxury vehicles are treated a little differently in an attempt to not allow people to abuse the tax code and write off a $300k Lamborghini.  Luxury vehicle limits are $58,000 for 2023.  If you purchase a car that cost over $58,000 and has a GWVR under the 6,000 lb threshold, there are special rules involved.

The max allowable depreciation, section 179 and bonus depreciation are all limited.  It’s very likely you will be depreciating a $100k vehicle for up to 13 years.  Car’s are generally depreciated over 5 years.

You MUST Keep Good Records

Accurate and detailed record-keeping is vital when claiming vehicle expense deductions. 

Get an app for your phone that tracks mileage.  I use MileIQ, but QuickBooks Online has one available as part of its software package.

Stay current with your miles tracking.  Make sure you go out every week and identify business versus personal miles.

Always use a credit or debit card when paying for your vehicle’s expenses.  Cash expenses are harder to prove, even with a receipt.  We have to think like an IRS auditor here.  If you were an auditor, would you be satisfied with your records?

State-Specific Rules to Know

I will admit I have to look up the various state rules I don’t know (I’m in CA).  Most states allow you to deduct your vehicle expenses in the same manner as the feds.  Some are just plain strange and take a percentage of SOME of the expenses.

What I have noticed is they all play off the federal calculation in some way.  This is just one more reason to properly track our total vehicle costs. 

Conclusion

Deducting your vehicle expenses is one of the most scrutinized areas of an IRS auditor.  Knowing the rules and keeping good records will go a long way in keeping you out of trouble in the event of an audit.

There are different rules as to what’s deductible depending on whether you purchased or leased the car.

The type of vehicle also matters.  Cars with a GWVR under 6,000 lbs, cars between 6,000 and 14,000, and vehicles with a GWVR over 14,000 all have a different set of rules.

Make sure you track all your mileage in a contemporaneous manner.  I recommend you put an app on your phone (I use MileIQ) that utilizes the GPS function your phone has.

MileIQ will log all your trips and save the data to their website.  You can then go out to your log and note which trips were for business and which were personal.

At year end you can print a report to help prepare your taxes.