An often overlooked tax planning opportunity comes from not fully understanding how you can use your cars as a deduction on your tax return. It is very common for people who have a Schedule C sole proprietor type business to claim their mileage on automobiles, but the privilege of using personal deductions on a tax return is not limited to someone who is filing a Schedule C. For instance, a landlord might own three apartment buildings and file a schedule E on his personal tax return and not feel like he is “self-employed” as he has a full-time W-2 job.
However, the use of his personal car on that schedule E is just as deductible as it is for the Schedule C sole proprietor, and honestly, who can generate any passive income without having some expenses? If you have an online eBay service, you drive to the post office to mail your packages. If you are a landlord, you drive to the hardware store to get nuts and bolts, and of course, drive to the properties when necessary. There’s almost always an automobile component to everything in our lives.
The topic of whether to actually claim mileage versus actual expenses is often overlooked as well. Many people who put in mileage were simply given that option by a tax preparer initially when they started generating income that included business use of a vehicle. The preparer didn’t think about the choice of actual expenses versus mileage.
What else do you need to know?
The IRS, when you first put a car into service on a 1040, gives you the option of using actual expenses or mileage, so what is the mileage deduction? It’s basically “actual expenses EZ”. Like many parts of the tax code, the IRS gives you the simple form method option of tracking automobile expenses. You could instead keep track of the tires, mufflers and other repairs, keep track of the cost of insurance, the tags, the upkeep, etc., and deduct those expenses at a certain ratio. But many people at tax time have not kept the receipts for those various expenses, and because it is bookkeeping intensive, so the IRS eventually came up with a methodology called “miles” where they are giving people a predetermined formula. This year that expense amounts to $0.56 a mile for business deductions, which represents what the average person would spend on gas, tires, oil, repairs, maintenance, if they drive their car a certain number of miles. In other words, $5,600 is estimated to be what you would have spent on gas, oil, mufflers, tires, etc. after driving 10,000 miles.
Is it always smart to use mileage? Not necessarily. Often, people with small businesses don’t really have to go many miles, but they have older cars that require more repairs and maintenance than a brand new car. For instance, a landlord lives six miles from two apartment buildings and nine miles from the hardware store. His average week would be 35 miles round trip to the properties. At $0.56 a mile, it’s a very small deduction against his taxes. Let’s assume he owns a nine-year-old vehicle that’s starting to wear out. When he puts that vehicle into service on his 1040, instead of using miles he could claim actual expenses.
He spends money on mufflers, tires and a transmission repair for that vehicle, for example, totaling $3,000, a portion of which is deductible for the landlord business. In this case, he would have three times the tax deduction by using actual expenses over miles. However, if the same landlord leases a brand new vehicle that’s under warranty, which covers oil changes, maintenance, and all other expenses for the next three years, then he should claim miles because, under the actual expenses model, he would have zero dollars expended. A deduction of $0.56 per mile for 30 or 40 miles a week is better than zero.
When you first put a car into service, trade cars, buy a new car, start a new business, you actually have to stop and think about how you’re going to use that vehicle, how the deductions work and whether you should use actual expenses or mileage. Once you’ve made the determination, however, if your circumstances change, you cannot change the formula with the IRS. They require that you continue to use actual mileage or actual expenses for the entire time that the vehicle is used in service for the business.
What If your situation changes?
Let’s assume that same landlord living a few miles away from an apartment building with a brand new car just started a common carrier business and is going to drive hundreds and hundreds of miles a week. How do you fix the problem? You could trade cars with your spouse. Take the car out of service from your landlord business and put it in service under the new business, and then you can change from actual expenses to mileage or vice versa.
The point is that this takes some “strategizing”. Going to a tax planning firm and not just a tax preparation firm can help you catch little things like the mileage versus actual expenses choice, which can make a difference of hundreds, even thousands of dollars of money back on your taxes, instead of somebody just automatically using mileage because it’s all they know.
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