Should you lease or buy a car for your business?

Key takeaways

• Leasing a car for your business offers tax benefits, like the ability to deduct lease payments.
• When you lease, every monthly payment you make toward your lease can be written off as a business expense, reducing your overall taxable income.
• Buying a car for your business offers significant tax benefits that leasing doesn’t provide, like the car loan interest deduction and the depreciation deduction.
• If you take out a loan to buy a car for your business, the interest you pay on that loan is generally tax-deductible.
• The IRS allows you to deduct a portion of the car’s cost each year, based on a predetermined depreciation schedule.
• Whether you lease or buy, you can deduct the miles you’ve driven for business purposes.
• You can deduct state and local sales tax, regardless of whether you buy or lease your business vehicle.
• Work with a Tax Pro who can help you determine whether buying or leasing a business vehicle offers greater tax benefits, and to make the most of every deduction.

Tax benefits of leasing a car for your business

Leasing a car for your business offers unique tax benefits. One of the standout tax advantages of leasing is the ability to deduct lease payments, which can directly reduce your taxable income. Additionally, the way sales tax is handled in a lease agreement can offer more tax benefits.

Plus, when you lease a vehicle, you gain the flexibility of lower upfront costs, as some leases do not require a down payment, and predictable monthly payments, which can help manage your business’s cash flow more effectively. The upfront and monthly costs for leasing a vehicle of the same make, model, and year are often less than when buying it. You can use those savings for other business needs and investments. Leasing also simplifies the process of upgrading to newer models, ensuring you always have access to the latest features and technologies without making a  significant investment every time you want to upgrade.

Lease payments deduction

If you lease a vehicle and use it solely for business purposes, you can generally deduct the full amount of your lease payments. This means you can write off every monthly payment you make towards your lease as a business expense, reducing your overall taxable income,  which could reduce your taxes.

On the other hand, if you use the leased vehicle for both business and personal purposes, you can only deduct the business portion of your lease payments. The deduction is based on the percentage of time you use the vehicle for business. For example, if you use the car 70% of the time for business and 30% for personal use, you can deduct 70% of your lease payments.

For high-cost vehicles, the IRS requires you to include an "inclusion amount" in your taxable income. This amount reduces the deductible lease expense and is based on the fair market value of the vehicle you’re leasing. This usually only affects luxury or high-value vehicles and is designed to limit the tax benefits for expensive cars.

In addition to the lease payments, you may also be able to deduct other costs associated with the leased vehicle, such as registration fees and insurance, if they are directly related to your business use.

Mileage deduction on a leased vehicle

To claim the mileage deduction, you need to keep track of how much you drive for business purposes and how much you drive for personal purposes. Only the miles you’ve driven for business purposes are eligible for the deduction. If you drive 15,000 miles in a year and 10,000 of those miles are for business, you can deduct the standard mileage rate for those 10,000 business miles.

The IRS sets the standard mileage rate each year, and it covers all the expenses related to operating your car, including gas, oil, repairs, tires, insurance, and registration fees. For instance, the standard mileage rate for 2024 is 67 cents per mile. If you drive 10,000 miles for business, you can deduct $6,700 (10,000 miles x 67  cents).

If you decide to use the standard mileage rate for a leased vehicle, you’ll be required to use this method for the entire term of the lease. You cannot switch to the actual expense method, which involves deducting specific expenses like gas and maintenance, once you've started using the standard mileage rate for that vehicle.

It’s smart to keep a log of your business trips, including the destination, date, the purpose of your trip, and how many miles you’ve driven. This will help to support your deduction if the IRS questions your return.

Tax benefits of buying a car for your business

Buying a car for your business can be a smart investment, and it offers several significant tax benefits that leasing doesn’t provide. When you purchase a vehicle, you gain the advantage of ownership, which opens opportunities for substantial tax deductions.

These benefits can help you offset the cost of the vehicle and reduce your overall income taxes. Unlike leasing, where deductions are typically limited to lease payments and business use, purchasing a vehicle allows for a wider range of deductions, including depreciation, interest on financing, and various operating expenses.

Car loan interest deductions

If you take out a loan to buy a car for your business, the interest you pay on that loan is generally tax-deductible. This means that you can write off the interest portion of your monthly car payments as a business expense, directly reducing your business’s taxable income. This can lead to significant tax savings over the life of the loan, especially if you have a high interest rate or a long loan term.

It's important to note that the car loan interest deduction is only available for vehicles you use for business purposes. Additionally, the vehicle must be used in your trade or business, and you must be the one legally obligated to pay the interest on the loan.

If you use the vehicle for both business and personal use, the interest deduction is only available for the portion you use for business purposes. To calculate this, you need to determine the percentage of miles driven for business versus personal use. For example, if you use the car 80% of the time for business and 20% for personal use, you can deduct 80% of the interest paid on the car loan.

As with other business expenses, accurate record keeping is essential for claiming car loan interest deductions. You should keep detailed records of your car loan statements.

Depreciation deduction

Depreciation is a way to account for the wear and tear on your business vehicle over time. The IRS does not allow you to write off the cost of the car immediately but allows you to deduct a portion of the car’s cost each year. This is based on a predetermined depreciation schedule and helps to offset the expense of purchasing a business vehicle.

There are different methods for calculating depreciation, but the two most common for vehicles are the Modified Accelerated Cost Recovery System (MACRS) and the straight-line method. MACRS allows you to take larger deductions in the earlier years of the vehicle's life, while the straight-line method spreads the deductions evenly over the vehicle’s useful life.

Another benefit, the Section 179 deduction, is a special provision that allows you to possibly deduct the full purchase price of your business vehicle the year you buy it. This can be a significant tax break if you need to offset a large amount of taxable income. However, there are limits to how much you can deduct under Section 179, and not all vehicles qualify, so it's important to check the IRS guidelines or work with a Tax Pro.

You may also qualify for bonus depreciation. This allows you to deduct a substantial portion of the vehicle’s cost in the first year of purchase. Unlike Section 179, bonus depreciation is not limited by your business’s taxable income. It can be used with the Section 179 deduction for even greater tax savings.

The depreciation deduction is only applicable to the portion of the vehicle you use for business purposes. To determine this, you need to calculate the percentage of miles you've driven for business versus personal use. For instance, if you use the car 70% for business and 30% for personal use, you can only depreciate 70% of the vehicle’s cost.

Be sure to maintain detailed records, including the purchase price of the vehicle, the date it was placed in service, and how much you use it for business versus personal purposes. Additionally, keep track of any improvements you’ve made to the vehicle, because these can affect the depreciation calculation.

Mileage deduction on a purchased vehicle

When you buy a car for your business, you can take advantage of mileage deductions to lower your taxable income. If you choose to use the standard mileage rate, which is set by the IRS, you can deduct a 67 cents per mile driven for business purposes for 2024.

Alternatively, you can use the actual expense method to deduct the costs associated with operating your vehicle. This includes expenses, like gas, oil, repairs, tires, insurance, and registration fees. To use this method, you must keep detailed records of all your vehicle-related expenses throughout the year.

Keep in mind that only the miles you’ve driven for business purposes are deductible, so accurate record keeping is essential.

Sales tax deduction: deduct state and local sales tax whether you buy or lease a vehicle.

Whether you buy or lease your business vehicle, you can deduct state and local sales tax.

When you buy a vehicle for business purposes, you pay sales tax on the full purchase price at the time of sale. This sales tax can be deducted on your federal tax return if you itemize your deductions. This one-time deduction can be significant, especially if you purchase a high-value vehicle, and can reduce your taxable income for the year you purchase the car.

For leased vehicles, sales tax is typically applied to your monthly lease payments rather than the total value of the car. This means you can deduct the sales tax you’ve paid as part of your lease payments each month. This approach spreads out the tax deduction over the lease term, providing ongoing tax relief and easing your financial responsibility each month.

The IRS allows you to choose between deducting state and local income taxes or state and local sales taxes. You cannot deduct both. This choice can maximize your tax savings depending on your specific situation. For instance, if you live in a state with high sales tax rates, it might be more beneficial to opt for the sales tax deduction.

To claim the sales tax deduction, it's crucial to keep detailed records of the sales tax paid. For a purchased vehicle, retain the purchase agreement and any sales tax receipts. For a leased vehicle, keep your lease agreements and monthly payment statements that show the sales tax paid.

Consult with a Jackson Hewitt Tax Pro to understand the tax benefits of each option

Choosing whether to buy or lease a car for your business involves weighing various tax benefits and financial considerations. Both options offer unique advantages that can significantly impact your taxable income and overall costs.

To ensure you make the best decision for your business, work with a Jackson Hewitt Tax Pro. We can help you understand the specific tax benefits of each option based on your unique situation.

About the Author

Mark Steber is Senior Vice President and Chief Tax Information Officer for Jackson Hewitt. With over 30 years of experience, he oversees tax service delivery, quality assurance and tax law adherence. Mark is Jackson Hewitt’s national spokesperson and liaison to the Internal Revenue Service and other government authorities. He is a Certified Public Accountant (CPA), holds registrations in Alabama and Georgia, and is an expert on consumer income taxes including electronic tax and tax data protection.

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