Businesses that use vehicles, or provide them for employees, often lease them instead of buying them. There are some tax advantages to doing that and often, the paperwork is a lot simpler.
But there are tax advantages for consumers who lease cars too. Most states, for example, charge sales tax on leased cars in a different way than cars purchased outright.
“In most states, you are paying tax only on the amount of the vehicle you use as opposed to the entire vehicle,” said Scot Hall, Executive Vice President Operations of Swapalease.com, a company matching consumers who want to assume someone's lease with consumers who want to get out of their lease. “Even if a business were not involved, I would argue that there are tax benefits from leasing.
Here's an example. Let's assume the vehicle cost $25,000. That's the gross capitalization cost. Next, let's assume you paid $2,000 of that in cash. That leaves the net capitalization cost at $23,000.
What will the car be worth at the end of the lease? That's the residual value, and in this case, let's assume it is $14,820. Your monthly payment is based on the difference between the net capitalization cost – $23,000 – and the $14,820 at the end of the lease.
Instead of paying sales tax in a lump sum payment at the time you purchase the vehicle, the sales tax in a lease arrangement is rolled into the monthly payment. And it's usually less than if you were purchasing the automobile.
“In most states, of course, how taxes are set on automotive leases in individual states will vary a little bit, you will be paying less tax when you lease as a consumer, whether you are set up as a business or not, as opposed to what you would pay if you were purchasing that vehicle,” Hall said.
Federal tax breaks
What about your federal taxes? If you operate a business and need a vehicle, you may find that leasing it yields more of a tax break than owning it. Record-keeping might also be a bit easier.
“With most leases you are able to write off a larger amount of the payment, if not the entire payment,” Hall said. “Assuming the vehicle is used for 100% business purposes, in most instances the full lease payment could be written off on a monthly basis as an expense. If they were purchasing the vehicle, they would have to set up a depreciation schedule, and typically that would be at a reduced expense level. That would keep them with a higher tax liability, at least in the short term.”
When you buy a vehicle and depreciate it on your taxes, the Internal Revenue Service (IRS) pays attention to what kind of vehicle it is. According to TurboTax, tax laws squeeze otherwise allowable depreciation deductions for vehicles that fall into the class of “luxury cars.” And the government has a much lower threshold of what it considers “luxury car” than you might have.
Leasing may be simpler
At any rate, the computations required for a purchased vehicle are, by and large, more complex than for leased autos – even ones not used exclusively in business.
“If a vehicle is used on a part-time basis for a business, it can usually be written off on a percentage basis,” Hall said. “For example, if the car were used half the time for business purposes it would allow you to write off half the monthly lease payment.”
Hall says it's always wise to check with your accountant or whoever handles taxes to make sure that what you want to do is something you can do.
If you are considering a new car purchase you may have noticed the TV ads with a lot of very attractive lease offers. In nearly every case, the monthly cost of a lease is going to be considerably less than a purchase, and the lease's structure – requiring you to only pay for the value of the car you are using – is mostly responsible.
“Cars are holding their value better and the better a car holds its value, the higher the residual value will be at the end of the lease, the higher the residual value, the lower the principal for the consumer,” Hall said.
But just as though you were purchasing the vehicle, it only becomes a good deal if you negotiate it that that way. Many consumers don't realize that a dealer will negotiate a lease, just as they would a sale. To dealers, there's very little difference. The consumer should view it the same way, and that means not paying so much attention to the monthly lease payment, but what the dealer is willing to sell it for.