Small business owners, including real estate agents, have two methods available for deducting their auto use: The Standard Mileage Rate and the Actual Cost Method. For real estate agents, the business auto use is often their most substantial deduction – so deciding which method to use is an important, financially consequential decision. In our article, Real Estate Agents, Auto Deduction Options: Standard Mileage Rate, we introduce these methods and share the process for utilizing as well as the pros & cons of the standard mileage rate. We also cover the auto deduction in detail in our Real Estate Agent Tax-Cut Library. In this article, we will discuss the Actual Cost method – the how-to and pro & cons of using this method.
The Actual Cost Method: Utilizing actual cost to deduct auto use is exactly like it sounds – you track and deduct business-related expense incurred by your vehicle(s). As with the standard mileage rate, you must record the miles you drive each vehicle during the year. You are required to track business miles, commuting miles (those driven to and from a W2 job or regular place of business), and the total miles put on the vehicle during the year. You must also record and categorize all expenses incurred for the vehicle.
Actual Vehicle Costs: Below is a list of ordinary auto expenses that must be tracked and categorized:
- Fuel/Gas: The stuff that makes your car “Go.”
- Repairs are work done to repair a defect that keeps the vehicle from running properly, such as replacing a fuel line or getting a new alternator.
- Maintenance is preventative in nature- it keeps the vehicle operating correctly. It includes scheduled services outlined in the owner’s manual, such as oil changes, wiper fluid, and filter replacements. It would also include tire changes on most vehicles.
- Insurance: This includes both liability and full coverage on your business-use vehicle. Be careful if you have multiple vehicles on one policy as you will need a breakdown of the premium for each car.
- License & Fees: License Fees include the cost of tags and inspections required to keep your vehicle street legal.
- Property Tax: As with insurance, if you receive a single tax bill for all personal property, you will need to determine the amount paid on business vehicles. When working with clients, I generally use a percentage of the total assessed value billed. For example, if the total assessed value is $20,000 and the assessed value of the business vehicle is $12,000, 60% ($12,000 / $20,000) of the assessed value is for the business vehicle. Therefore, you can allocate 60% of the personal property tax bill to the business-use vehicle.
- Garage Rent: Costs paid to store your vehicle overnight or for prolonged periods. For instance, if you live in a condo and pay a monthly fee to park your car in the building’s lot, this fee is considered garage rent. Garage rent, however, does not include charges to park while running business errands.
- Interest on Auto Loan: If you finance your business-use vehicle, you can deduct the interest paid on that vehicle during the year.
Business Use Percentage: The deduction allowed for the expenses listed above is based on the percentage of miles you drive for business during the year. For example, if the auto was driven a total of 10,000 miles during a year, and 3,500 of those miles were for business, 35% of the expenses listed above are deductible as auto expenses. Note: When using tax software to prepare your return, be sure to enter total annual costs into the program. If you enter your mileage correctly, the software should calculate the appropriate deduction.
Fully Deductible Auto Expenses: There are a few auto expenses you can deduct in full, regardless of the business-percentage-use of a vehicle because they directly relate to business:
- Temporary Parking: The cost of parking for business trips are fully deductible. However, parking costs at your primary place of business (for example, regular parking at your broker’s office when you don’t have a qualified home office) is not deductible.
- Valet Services: Reasonable valet costs and tips on business trips are deductible.
- Fees to travel on certain bridges and roadways are fully deductible if paid during a deductible business trip.
Fines and Penalties Not Deductible: Fines and penalties for a violation of the law are not deductible on a tax return. This includes parking, speeding tickets as well as fines for dead tags or inspection stickers.
Depreciation of Business Vehicle: Depreciation is the most confusing (and beneficial) aspects of deducting actual auto costs. Depreciation is highly complex and made even more complicated by two related deductions: Bonus Depreciation and the 179 Expense (discussed below).
Pros & Cons of Deducting Actual Auto Expenses: Although most agents will find that the Standard Mileage Rate is a more straightforward deduction that yields similar or higher tax savings, there are certain circumstances in which the Actual Cost Method may generate a larger tax deduction (as discussed below).
Pros of Actual Cost Method: The primary benefit of utilizing the Actual Cost Method is straight forward – it can prove a larger deduction for agents who drive expensive vehicles or those that get poor gas mileage.
- Depreciation Can Result in Much Higher Deduction: Driving a newer, upscale vehicle can impact your brand in the marketplace. The amount of this impact depends on the types of properties you sell and customers who buy them. One of the benefits of purchasing an upscale business vehicle is its deductibility via depreciation. The vehicle may also qualify for Bonus Depreciation (which allow one to deduct more in the year of purchase than standard rules allow) and the Section 179 Expense (which allows the deduction of an elected portion of the vehicle in the year of purchase).
As mentioned above, the benefits of depreciation come at a cost. Auto depreciation is one of the most complicated areas of taxation. The law limits depreciation on most vehicle models as well as when and how Bonus Depreciation and the 179 Expense can be deducted. Making depreciation even more challenging to share in a book or article is Congress’s proclivity to change the rules that govern it. When this happens, as it regularly does, all previously written articles and books on the subject are made obsolete.
The complexity and rule-change misinformation make depreciation-based return-errors all too common. It is for this reason that I recommend that agents benefiting from actual auto costs hire a tax professional to prepare their returns. If, however, you’re a diehard do-it-yourselfer, this article covers the basics.
- Poor Mileage Can Result in Higher Deduction: The IRS bases its standard mileage rate on average vehicle operating costs, including fuel consumption. As a result, agents who drive larger, high-profile vehicles or those with more powerful engines may benefit from the actual cost method.
- Planning Opportunities: Real estate agents who own a vehicle they don’t put many miles on (think the garage-kept convertible) may make a large portion of this vehicle’s cost deductible with some effective tax planning.
Cons of Deduction the Actual Cost Method: There are a few challenges faced by those who deduct the actual cost method. Below is a list of those challenges.
- Complexity of Vehicle Depreciation: This increases the risk of tax return errors. It also generates the additional cost of hiring a professional when one wishes to minimize this risk.
- Additional Recordkeeping: Both the standard mileage rate and the actual cost method require an owner to track business, commuting, and personal mileage for each business vehicle. The actual cost method, however, takes this requirement a few steps further. Those claiming actual costs must track and categorize all expenses related to each vehicle used for business. This requires a level of organization and discipline that many individuals lack. It also involves a time-commitment that can draw attention away from making clients happy and getting new clients!
- Start with Actual, Stuck with Actual: If you use the actual cost method the first year you place your vehicle in service, you have to use it as long as you use the vehicle for business. On the other hand, if you use the standard cost method the first year you place the vehicle in service, you can switch between the standard mileage rate and the actual cost method in subsequent years.
- More “Risky:” I put the term risky in quotes because, although the actual cost method may not be a bright red audit-triggering flag, it is a deduction that yields a high percentage of errors on tax returns. If a return claiming actual auto costs is audited, one can expect to have this deduction scrutinized by the IRS.
Takeaway: The actual auto cost method may benefit Real Estate Agents who use expensive vehicles or those with poor gas mileage (i.e., they are more costly to operate than the standard mileage rate allows). Agents who are incredibly organized and who possess the discipline required to track every auto expense will benefit most from the deduction. As mentioned in our article on the standard mileage rate, most agents – especially part-time agents - will find that the Actual Cost method is a lower deduction and not worth the time and effort.
Summary and Invite: We hope this article has helped you to understand the actual cost method of deducting business use of your vehicle. If you’d like to learn more about cutting your most significant expense, TAXES, check out our Real Estate Agent Tax Cut Library. The Real Estate Agent Tax Cut Library includes over eight hours of video broken into twenty-nine searchable volumes and covers every possible deduction a Real Estate Agent can take on their tax return. Our Broker Version will help your entire agency cut their taxes! We also invite you to browse our courses.