IRS Rolls out New Luxury Car Rules

IRS “luxury automobile” limits were recently adjusted for inflation. The new limits affect certain deductions taxpayers can take for passenger automobiles — including light trucks and vans — used in their businesses. Revenue Procedure 2019-26 lists different limits for purchased automobiles, whether or not eligible for bonus first-year depreciation, as well as for leased automobiles.

What changed under tax reform?

The 2017 Tax Cuts and Jobs Act (TCJA) extended and modified bonus depreciation for qualified property purchased between September 27, 2017, and January 1, 2023, including business vehicles. Businesses can expense 100% of the cost of such property (subject to certain conditions) in the year the property is placed in service.

This deduction will phase out beginning in 2023, dropping 20 percentage points each year until it vanishes in 2027, unless Congress acts to extend it. The applicable percentage is 30 percent for qualified property acquired before September 28, 2017, and placed in service in 2019.

However, that bonus depreciation is available only for heavier business vehicles, not passenger cars. The maximum bonus depreciation amount for passenger automobiles is much smaller.

Regulation IRC Sec. 280F limits the depreciation deduction allowed for luxury passenger cars for the year they’re placed into service and each succeeding year. The TCJA amended the provision to increase the Sec. 280F first-year limit for qualified property acquired and placed after September 27, 2017, by $8,000. It increased the limit on first-year depreciation for qualified property acquired before September 28, 2017, and placed in service in 2019, by $4,800. These amounts are the bonus depreciation.

Bonus depreciation caps

The new guidance includes three depreciation limit tables for purchased autos placed in service in calendar year 2019. The limits for automobiles acquired before September 28, 2017, that qualify for bonus depreciation are:

  • 1st tax year: $14,900
  • 2nd tax year: $16,100
  • 3rd tax year: $9,700
  • Each succeeding year: $5,760

The limits for autos acquired after September 27, 2017, that qualify for bonus depreciation are:

  • 1st tax year: $18,100
  • 2nd tax year: $16,100
  • 3rd tax year: $9,700
  • Each succeeding year: $5,760

The limits for autos that don’t qualify for bonus depreciation are:

  • 1st tax year: $10,100
  • 2nd tax year: $16,100
  • 3rd tax year: $9,700
  • Each succeeding year: $5,760

More fine print

The bonus depreciation deduction isn’t available for automobiles for 2019 if the business:

  • Didn’t use the automobile more than 50% for business purposes in 2019
  • Elected out of the deduction for the class of property that includes passenger automobiles (that is, five-year property)
  • Purchased the automobile used and the purchase didn’t meet the applicable acquisition requirements (for example, the business cannot have used the auto at any time before acquisition)

Luxury leasing limits

The new guidance also presents a so-called “income inclusion” table for passenger automobiles first leased in 2019 with a fair market value (FMV) of more than $50,000. The FMV is the amount that would be paid to buy the car in an arm’s-length transaction, generally the capitalized cost specified in the lease.

Taxpayers that lease a passenger automobile for use in their business can deduct the part of the lease payment that represents the business use. Thus, if the car is used solely for business, the full cost of the lease is deductible. (Alternatively, you could just deduct the standard mileage rate — 58 cents for 2019 — for business miles driven.)

However, Sec. 280F requires the deduction to be reduced by an amount that’s substantially equivalent to the limits on the depreciation deductions imposed on owners of passenger automobiles. The idea is to balance out the tax benefits of leasing a luxury car instead of purchasing it. That’s where the table comes into play.

Lessees must increase their income each year of the lease to achieve parity with the depreciation limits. The income inclusion amount is determined by applying a formula to an amount obtained from the IRS table. The latter amount depends on the initial FMV of the leased auto and the year of the lease term. Although the $50,000 FMV threshold for 2019 is unchanged from 2018, many of the other values in the new table have changed.

For example, let’s say you leased a car with an FMV of $56,500 on January 1, 2019, for three years and placed it in service that same year. You use the car for business purposes only. According to the table, your income inclusion amounts for each year of the lease would be as follows:

  • Year 1: $26
  • Year 2: $59
  • Year 3: $86

The annual income inclusion amount may seem small compared to the depreciation deduction limits, but it represents a permanent tax difference that affects the effective tax rate but not book or taxable income. The depreciation limits, on the other hand, represent a timing difference that affects book and taxable income in the same way but at different times and doesn’t change the effective tax rate. The business will recover the timing difference through depreciation deductions or when it disposes of the auto.

Watch the road

The new tax rules for vehicles used in business generally are favorable but aren’t easy to navigate. If you’d like advice on making your way through the obstacle course, Weaver can help steer you toward the best strategy given your current circumstances. Contact us to ask a question or request a consultation.

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