Lease or buy a car for business use?
August 25, 2014 11:29 PM Subscribe
I'm trying to decide between leasing or buying a car. It would be anywhere from 50-100% business use. Does this make a difference?
I grew up in a family that abhors borrowing money and paying interest for anything if it can at all be avoided. Great, but my family's never owned a business, so they don't really get that what makes sense for personal finance may not always make sense for business finance.
Fast forward to me. My wife and I are considering a second car, and as it happens, it would be used at least 50% (as potentially as much as 100%) for business purposes. I am the sole member of a Virginia LLC (though we live in Maryland), and therefore, we could buy or lease the car through the company if there are advantages to doing so. What I'm attempting to determine is whether or not this would make sense for us.
I've read some things online more or less condemning the current tax code for "essentially subsidizing the luxury car purchases of business owners" and stuff like that, with the tl;dr being that business owners are leasing fancy cars because of loopholes in the tax code that allow them to basically deduct the ALL of the lease payments on that car each year on their taxes. Is this actually true? Or are the things I've read online outdated now? I've read about the add-backs, inclusion amounts, etc. and I THINK I get it, but I'm still not entirely sure.
To provide some real numbers, I'm looking at potentially lading a car with a $45K to $50K fair-market value (only because it's new, since if you're leasing, you pretty much have to do a current model-year car; if we were buying I'd go with gently-used two-year-old car). With $5K down and mediocre credit, that means roughly $550 to $600ish monthly payments on a 36-month lease (conservatively; it could be less). Does this mean that (multiplying by 12), we can deduct anywhere from $6,600 to $7,200 (monthly lease payment x 12) from our income each year on our taxes (minus the negligible inclusion amount, and assuming 100% business use of the vehicle)?
The other option is to purchase a gently used vehicle with a fair market value of $35K to $40K (since financing entails higher monthly payments) and keeping it for 3-5 years. Any potential business-use-of-a-vehicle credits would be explored and used also, but I keep reading that when it comes to business use, leasing often is the better deal. With these numbers, what's the better way to go?
I grew up in a family that abhors borrowing money and paying interest for anything if it can at all be avoided. Great, but my family's never owned a business, so they don't really get that what makes sense for personal finance may not always make sense for business finance.
Fast forward to me. My wife and I are considering a second car, and as it happens, it would be used at least 50% (as potentially as much as 100%) for business purposes. I am the sole member of a Virginia LLC (though we live in Maryland), and therefore, we could buy or lease the car through the company if there are advantages to doing so. What I'm attempting to determine is whether or not this would make sense for us.
I've read some things online more or less condemning the current tax code for "essentially subsidizing the luxury car purchases of business owners" and stuff like that, with the tl;dr being that business owners are leasing fancy cars because of loopholes in the tax code that allow them to basically deduct the ALL of the lease payments on that car each year on their taxes. Is this actually true? Or are the things I've read online outdated now? I've read about the add-backs, inclusion amounts, etc. and I THINK I get it, but I'm still not entirely sure.
To provide some real numbers, I'm looking at potentially lading a car with a $45K to $50K fair-market value (only because it's new, since if you're leasing, you pretty much have to do a current model-year car; if we were buying I'd go with gently-used two-year-old car). With $5K down and mediocre credit, that means roughly $550 to $600ish monthly payments on a 36-month lease (conservatively; it could be less). Does this mean that (multiplying by 12), we can deduct anywhere from $6,600 to $7,200 (monthly lease payment x 12) from our income each year on our taxes (minus the negligible inclusion amount, and assuming 100% business use of the vehicle)?
The other option is to purchase a gently used vehicle with a fair market value of $35K to $40K (since financing entails higher monthly payments) and keeping it for 3-5 years. Any potential business-use-of-a-vehicle credits would be explored and used also, but I keep reading that when it comes to business use, leasing often is the better deal. With these numbers, what's the better way to go?
Talk to an accountant but yeah generally you have the details correct. I think it might be problematic if the LLC generates less revenue our has less Capital than the lease expense, but assuming it's a real biz you broadly have the tax deduction correct.
posted by JPD at 2:32 AM on August 26, 2014 [1 favorite]
posted by JPD at 2:32 AM on August 26, 2014 [1 favorite]
Experience level: My wife is self-employed and occasionally uses her car for business purposes. Also, my father owned his own company (in New York State) -- he recently sold the company and retired. My mother was the bookkeeper for the company; she worked from home most of the time and I paid some attention to her complaining about things growing up. All of their personal vehicles were officially registered to the company and were on occasion used for company business.
However, I am not an accountant. Also, the company was not an LLC but a Sub Chapter S corporation. I have no idea what either of those terms mean. So, you should hire an accountant to advise you on these things.
If you buy the car through the business, you can use the depreciation of the car as an annual tax deduction (at least on Federal taxes). You can also deduct the mileage used for business -- I think the rate is something like 51c per mile (it changes each year), and that amount is supposed to cover normal wear and tear on a car including gas, oil changes, tires, maintenance, et cetera. Keep written records of where you drive for work and how many miles.
Not sure about VA or MD taxes for these deductions.
posted by tckma at 5:21 AM on August 26, 2014
However, I am not an accountant. Also, the company was not an LLC but a Sub Chapter S corporation. I have no idea what either of those terms mean. So, you should hire an accountant to advise you on these things.
If you buy the car through the business, you can use the depreciation of the car as an annual tax deduction (at least on Federal taxes). You can also deduct the mileage used for business -- I think the rate is something like 51c per mile (it changes each year), and that amount is supposed to cover normal wear and tear on a car including gas, oil changes, tires, maintenance, et cetera. Keep written records of where you drive for work and how many miles.
Not sure about VA or MD taxes for these deductions.
posted by tckma at 5:21 AM on August 26, 2014
This page on business use of vehicles has some great information.
posted by Falwless at 6:23 AM on August 26, 2014
posted by Falwless at 6:23 AM on August 26, 2014
Have you compared the cost of leasing a new car minus the deductions VS. buying a used car minus the deductions for mileage plus resale value? In 2014 the IRS allows 56 cents per mile - if you drive a lot, it becomes a significant chunk of change. For example, if you log 20,000 miles a year your deduction will be $11k vs. only $7k in deductions if you are leasing (your "break-even" is about 12,000 miles). Now add the fact that you could buy a very nice used car for half of the same model new AND sell or donate the car at some point down the road, and it makes even more sense to buy used.
FWIW, my husband has a business where he drives a lot and our calculations showed that we'd save more by doing #2.
posted by rada at 7:24 AM on August 26, 2014
FWIW, my husband has a business where he drives a lot and our calculations showed that we'd save more by doing #2.
posted by rada at 7:24 AM on August 26, 2014
Leasing works best in situations where having vehicles regularly updated (without the hassle of selling them) and having predictable and stable outgoings is important. The tax deductions should more or less match the expense in either case so buying a cheaper vehicle will generally cost you less than leasing a more expensive one.
My business has bought half a dozen vehicles over time and we usually do what's called a chattel mortgage, which is just a loan we pay monthly for 4-5 years and at the end of it we own the vehicle. We've paid cash for a few as well. We also claim depreciation every year on assets - the reduction of value of the vehicle over time is a business expense - something you can't do when leasing.
It's always worth remembering though, that if your cash flow can support paying up front for this, or even a significant part of it, then there is no getting round the fact that avoiding paying interest is always better than claiming some proportion of it back as a tax deduction. The only reason anyone should borrow for a business asset is if they can't raise the cash or have something better to do with the cash they do have available.
We bought 2 vehicles in 2009, one with finance and one outright because we had the funds available. Paying cash saved us $8,500 in interest on a $40,000 vehicle over 4 years. We can claim the interest as an expense, but that only reduces the tax by a maximum of about 50%, so it would still have costs us around $4,250 in interest. All this assumes 100% business use which is how we tend to do it.
It is almost always cheaper to avoid finance or leasing if you can. It's just that businesses rarely have the cash available to do it for large assets.
I'm in AU and the details are a bit different in the US - your mileage rate will tilt it one way or another if you do lots or very few business miles - but the principles are the same; as is the value of an accountant. I agree that you should get one to give you specific advice.
posted by mewsic at 7:40 AM on August 26, 2014
My business has bought half a dozen vehicles over time and we usually do what's called a chattel mortgage, which is just a loan we pay monthly for 4-5 years and at the end of it we own the vehicle. We've paid cash for a few as well. We also claim depreciation every year on assets - the reduction of value of the vehicle over time is a business expense - something you can't do when leasing.
It's always worth remembering though, that if your cash flow can support paying up front for this, or even a significant part of it, then there is no getting round the fact that avoiding paying interest is always better than claiming some proportion of it back as a tax deduction. The only reason anyone should borrow for a business asset is if they can't raise the cash or have something better to do with the cash they do have available.
We bought 2 vehicles in 2009, one with finance and one outright because we had the funds available. Paying cash saved us $8,500 in interest on a $40,000 vehicle over 4 years. We can claim the interest as an expense, but that only reduces the tax by a maximum of about 50%, so it would still have costs us around $4,250 in interest. All this assumes 100% business use which is how we tend to do it.
It is almost always cheaper to avoid finance or leasing if you can. It's just that businesses rarely have the cash available to do it for large assets.
I'm in AU and the details are a bit different in the US - your mileage rate will tilt it one way or another if you do lots or very few business miles - but the principles are the same; as is the value of an accountant. I agree that you should get one to give you specific advice.
posted by mewsic at 7:40 AM on August 26, 2014
You need to talk to an accountant because it's going to come down to how it affects your taxes. What you really need to do is assume that, whether you buy or lease, you're going to get rid of the car in 36 months.
For example, look at Edmund's "True-cost-of-ownership" for the 2014 BMW 3-Series, specifically, look at the depreciation.
If you lease that car (and I'm going assume the lease rate is the $550/mo you listed above, it should be pretty close), you'll pay a grand total of $19,800 and at the end of the lease, you're done with the car. The depreciation over that period is a total of $17,905. The difference is basically interest (called the "money factor" when leasing), some fees, and some uncertainty (since Edmunds/the lease company is predicting the future depreciation of this car). With a lease, at least in concept, the lease payment is the depreciation which is why it's just a straight tax deduction (I am not an accountant/I am not your accountant).
If, however, you buy something like a 2012 BMW 5-Series for about $37,700, you'll be paying $635/mo (60-month loan at 3%+7% sales tax and $5,000 down) for 36-months and then sell the car for around $24,000 (today's value minus years 1, 2, and 3 of depreciation and values on 2009 BMW 5-Series confirms this estimate).
So you'll only have paid $635*36+$5,000-$24,000=$3,860 for the car over the same three years, add a couple thousand to that if you would trade it in instead of sell it yourself. Ironically the math says that you're better off putting nothing down and paying $725*36-$24,000=$2,100 but you have to sell the car in 36-months for that to stay true.
All of the other costs (fuel, maintenance, etc.) should be the same.
To really compare those as accurately as possible, you'd need to figure out an interest rate and treat all of those values as a time-value of money problem and discount them back to today's value.
The reasons that leasing looks like terrible value is because 1. we're not factoring in the time-value of money and 2. we're not looking at buying vs. leasing the same car (buying the 3-series new would end up costing around $10,000 over the same 36-months). Mostly it's that used cars are a much MUCH better value than new cars. I used to sell new cars for a living and there are precious few scenarios where a new car is a better value than a used one.
You need to make a reasonable estimate of how many miles you'll actually be driving (total over the next 36-months), figure out what a lease will cost you (I might e-mail the internet sales person at a dealership and get some real numbers), and you can figure out what a used car will cost easy enough from looking at interest rates and used car listings.
Then you can take all of that to your accountant and figure out what the tax deductions will save you in each scenario.
One last thing that is a supposed advantage to leasing is that it insulates you from changes in depreciation (which is one of the reasons it was introduced as a way to finance a car). So if you lease a 3-Series (as an example) and during your lease some of them develop self-awareness and go on human killing rampages, the resale value will suffer but if you leased it, that's the lease company's problem. It does actually happen from time-to-time, Ford had the tire debacle with Explorers, Toyota and the "sudden acceleration", Audi had a shifter problem with their automatics that allowed the car to slip into reverse and run over the driver as they got something out of the trunk. That last one turned out to be mostly operator error but it was, supposedly, the thing that originally drove Audi to start leasing their cars (which may have been bullshit from one of my former managers in the car business).
posted by VTX at 7:44 AM on August 26, 2014 [1 favorite]
For example, look at Edmund's "True-cost-of-ownership" for the 2014 BMW 3-Series, specifically, look at the depreciation.
If you lease that car (and I'm going assume the lease rate is the $550/mo you listed above, it should be pretty close), you'll pay a grand total of $19,800 and at the end of the lease, you're done with the car. The depreciation over that period is a total of $17,905. The difference is basically interest (called the "money factor" when leasing), some fees, and some uncertainty (since Edmunds/the lease company is predicting the future depreciation of this car). With a lease, at least in concept, the lease payment is the depreciation which is why it's just a straight tax deduction (I am not an accountant/I am not your accountant).
If, however, you buy something like a 2012 BMW 5-Series for about $37,700, you'll be paying $635/mo (60-month loan at 3%+7% sales tax and $5,000 down) for 36-months and then sell the car for around $24,000 (today's value minus years 1, 2, and 3 of depreciation and values on 2009 BMW 5-Series confirms this estimate).
So you'll only have paid $635*36+$5,000-$24,000=$3,860 for the car over the same three years, add a couple thousand to that if you would trade it in instead of sell it yourself. Ironically the math says that you're better off putting nothing down and paying $725*36-$24,000=$2,100 but you have to sell the car in 36-months for that to stay true.
All of the other costs (fuel, maintenance, etc.) should be the same.
To really compare those as accurately as possible, you'd need to figure out an interest rate and treat all of those values as a time-value of money problem and discount them back to today's value.
The reasons that leasing looks like terrible value is because 1. we're not factoring in the time-value of money and 2. we're not looking at buying vs. leasing the same car (buying the 3-series new would end up costing around $10,000 over the same 36-months). Mostly it's that used cars are a much MUCH better value than new cars. I used to sell new cars for a living and there are precious few scenarios where a new car is a better value than a used one.
You need to make a reasonable estimate of how many miles you'll actually be driving (total over the next 36-months), figure out what a lease will cost you (I might e-mail the internet sales person at a dealership and get some real numbers), and you can figure out what a used car will cost easy enough from looking at interest rates and used car listings.
Then you can take all of that to your accountant and figure out what the tax deductions will save you in each scenario.
One last thing that is a supposed advantage to leasing is that it insulates you from changes in depreciation (which is one of the reasons it was introduced as a way to finance a car). So if you lease a 3-Series (as an example) and during your lease some of them develop self-awareness and go on human killing rampages, the resale value will suffer but if you leased it, that's the lease company's problem. It does actually happen from time-to-time, Ford had the tire debacle with Explorers, Toyota and the "sudden acceleration", Audi had a shifter problem with their automatics that allowed the car to slip into reverse and run over the driver as they got something out of the trunk. That last one turned out to be mostly operator error but it was, supposedly, the thing that originally drove Audi to start leasing their cars (which may have been bullshit from one of my former managers in the car business).
posted by VTX at 7:44 AM on August 26, 2014 [1 favorite]
We also claim depreciation every year on assets - the reduction of value of the vehicle over time is a business expense - something you can't do when leasing.
Yeah in the US tax depreciation for cars is limited whereas lease deductibility is not, hence the appeal of leasing for business owners. Without that bizarre twist it would probably always be better to buy. Also if you buy a lower priced car there isn't an advantage to leasing.
VRX's analysis doesn't take that into account.
Its one of those tax code things that make no sense.
posted by JPD at 1:46 PM on August 26, 2014
Yeah in the US tax depreciation for cars is limited whereas lease deductibility is not, hence the appeal of leasing for business owners. Without that bizarre twist it would probably always be better to buy. Also if you buy a lower priced car there isn't an advantage to leasing.
VRX's analysis doesn't take that into account.
Its one of those tax code things that make no sense.
posted by JPD at 1:46 PM on August 26, 2014
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2. People lie about shit like this all the time on their returns which is sometimes financially adventageous.
2. a. If you have an accountant prepare and file your taxes then not only are you less likely to get audited [the IRS is afraid of letterhead] but if you are audited, per contract, your accountant is liable for the penalties.
3. See 1 above.
I've owned a couple of businesses and an accountant with experience in your business should be the first stop. They will save you more than they cost and any decent one will not charge you until you are profitable. Not only do they have experience in how a business suceeds or fails - so you can get free advice - they are by the nature of your relationship invested in your success. I can't state this strongly enough. Accountant.
posted by vapidave at 2:04 AM on August 26, 2014