depreciation

Tax Depreciation Rules Business Automobiles

How do tax depreciation rules apply to business automobiles?
How do tax depreciation rules apply to business automobiles? 850 500 smolinlupinco

If you use an automobile in your trade or business, you may question how depreciation tax deductions are determined. The rules are complex. In particular, special limitations apply to business vehicles classified as passenger autos (which include many pickups and SUVs). Often, these limitations result in longer-than-expected wait times to depreciate a vehicle completely.

As you review the details below, remember that the rules are different if you lease an expensive passenger auto you use for business. (Reach out for more details.) 

The cents-per-mile rate includes the cost of depreciation

For passenger autos, separate depreciation calculations only apply if you use the actual expense method to determine your deductions. If you use the standard mileage rate instead, depreciation is already included in that rate. For 2023, the standard mileage rate is 65.5 centers per business mile driven. 

Using the actual expense method to calculate depreciation for passenger automobiles

You must make a separate depreciation calculation for each year until the vehicle is fully depreciated if you choose to use the actual expense method to calculate your allowable deductions for a passenger automobile.

Generally, you can calculate depreciation over a six-year span as follows:

Year 1: 20% of the cost

Year 2: 32% of the cost

Year 3: 19.2% of the cost

Year 4: 11.52% of the cost

Year 5: 11.52% of the cost

Year 6: 5.76% of the cost

Note: If 50% or less of the use of the vehicle is for business purposes, you MUST use the straight-line method to calculate depreciation deductions, NOT the percentages listed above.

Depreciation ceilings

You’re limited to specified annual depreciation ceilings for passenger autos that cost more than the applicable amount for the year the vehicle is placed in service. These ceilings may change annually and are indexed for inflation.

For example, for a passenger auto placed in service in 2023 that cost more than a certain amount, the Year 1 depreciation ceiling is $20,200 if you choose to deduct first-year bonus depreciation. The annual ceilings for later years are as follows: Year 2, $19,500; Year 3, $11,700; and for all later years, $6,960 until the vehicle is fully depreciated.

To account for non-business use, these ceilings are proportionately reduced depending on the amount the vehicle is used for business vs. personal use. 

Reminder: Bonus depreciation will be phased out

Under the Tax Cuts and Jobs Act, bonus depreciation will be phased down to zero in 2027 unless Congress acts to extend it. 

In 2023, the deduction is 80% of eligible property. In 2024, it’s scheduled to decrease to 60%. 

Pickups, Heavy SUVs, and vans

If you have heavy SUVs, vans, or pickups that you use for business purposes over 50% of the time, you may be able to take advantage of more favorable depreciation rules. That’s because vehicles with a gross vehicle weight rating (GVWR) of over 6,000 pounds are treated as transportation equipment for depreciation purposes.

To determine whether your vehicle falls into this category, check the inside edge of the driver’s side door for the vehicle’s GVWR.

Depreciation limits change the after-tax cost of passenger autos used for business

These depreciation limits impact the after-cost tax of your business vehicles. The true cost of business assets is decreased in proportion to the tax savings from related depreciation deductions.

To the extent depreciation deductions are reduced and thereby deferred to future years, so is the value of the related tax savings, thanks to time-value-of-money considerations. Therefore, the true cost of the asset may be that much higher.

Questions? Smolin can help.

As you can see, tax depreciation rules for business automobiles are complex and constantly evolving. If you’re considering purchasing a new business vehicle soon, please contact us for the most personalized, up-to-date guidance.

Listing home vacation rental tax impacts

Listing your home as a vacation rental? Here are the tax impacts to watch for
Listing your home as a vacation rental? Here are the tax impacts to watch for 850 500 smolinlupinco

Whether in the mountains or a waterfront community, many Americans dream of owning their perfect vacation home. If you already own a second house in a desirable area, you might consider renting it out for part of the year.

Before you post that listing, though, take a moment to learn about the tax implications. Taxes for these transactions can be complicated. They are determined based on how many days the home is rented, as well as a few other factors.

Vacation use by yourself and family members (even if you charge them rent) may impact that amount of taxes you pay. Use by nonrelatives will also affect your rate if market rent isn’t charged.

Tax rates for short-term rentals

Did you know that if you rent a property out for less than 15 days during the year, it’s not treated as “rental property” at all? For tax purposes, any rent you receive for this timeframe won’t be included in your income. This can lead to revenue and significant tax benefits in the right circumstances.

There is a drawback to this, though. You can only deduct property taxes and mortgage interest—not depreciation or operating costs. (Mortgage interest is deductible on your principal residence and one other home, subject to certain limits.)

Tax rates for longer rentals

You must include rent received for property rented out more than 14 days in your income for tax purposes. In this scenario, you may deduct part of your depreciation and operating expenses (subject to certain rules). 

However, navigating the numbers can prove challenging. You must allocate which portion of certain expenses are incurred via personal use days vs. rental days, such as: 

  • Maintenance
  • Utilities
  • Depreciation allowance 
  • Taxes
  • Interest

Both the personal use portion of taxes and the personal use part of interest on your second home may be deducted separately. To be eligible, the personal use part of interest must exceed the greater of 14 days or 10% of the rental days. Depreciation on the personal use portion of time is not deductible. 

Losses may be deductible

If allocable deductions are lower than your rental income, you must report the deductions and the rent to determine the amount of rental income you should add to your other income. If expenses exceed the income, it may be possible to claim a rental loss.

The number of days you use the house for personal purposes is important here. If you used the home for more than the greater of 14 days or 10% of the rental days, you used it “too much” to claim your loss.

In this instance, you may still be able to wipe out the rental income using your deductions. However, you can’t create a loss. Deductions you can’t claim will be carried forward, and you may even be able to use them in future years. 

If you can only deduct rental expenses up to the amount of rental income you received, you must prioritize the following deductions:

  • Interest and taxes
  • Operating costs
  • Depreciation

Even if you “pass” the personal use test, you must still allocate your expenses between the personal and rental portions. In this case, though, rental deductions that exceed rental income may be claimed as a “passive” loss (and will be limited under passive loss rules.) 

Questions? Smolin can help.

Tax rules regarding vacation rental homes can be confusing. We only discuss the basic rules above, and additional rules may apply to you if you’re considered a small landlord or real estate professional.

That’s why it’s best to consult with a tax professional before planning your vacation home use. Contact the friendly tax experts at Smolin to learn more.

Tax Rules depreciating business assets evolving. What to expect.

Tax Rules for depreciating business assets are evolving. Here’s what to expect.
Tax Rules for depreciating business assets are evolving. Here’s what to expect. 850 500 smolinlupinco

The Tax Cuts and Jobs Act relaxed the rules for depreciating business assets. Each year, the amounts change in proportion to inflation adjustments. With the remarkably high inflation rate we saw in 2023, this year’s adjustments are significant.

Here’s what you need to know for your small business.

Section 179 deduction amounts

The maximum Sec. 179 deduction is $1.16 million for qualifying assets placed in service in 2023. If your business puts qualified assets worth more than $2.89 million in service, though, that deduction begins to dwindle. 

What assets are eligible?

Eligible assets include depreciable personal property such as:

  • Machinery and equipment
  • Office furniture
  • Fixtures like refrigerators, signs, air conditioners, or heaters
  • Eligible improvements to commercial property like roofs, security systems, and HVAC
  • Computer hardware and peripherals
  • Vehicles (with some restrictions)
  • Commercially available software

Considerations for real estate

You may also claim Sec. 179 deductions for real estate qualified improvement property (QIP) up to the maximum allowance of $1.16 million. To do this, the improvements must be on the inner portion of a non-residential building and must take place after the date the building was placed in service.

However, it’s worth noting that expenditures relating to making a building bigger—such as elevators, escalators, or other internal structural changes—don’t count as QIP. They usually must be depreciated over 39 years.

There’s no separate Sec. 179 deduction limit for QIP, so deductions reduce your maximum allowance dollar for dollar.

Sec. 179 deductions are also allowed for qualified expenditures for security systems, fire protection systems, HVAC equipment, and alarm systems. 

Depreciable personal property used primarily to furnish lodging, like furniture and appliances in certain rental properties, may also qualify.

Heavy SUVs are deducted differently

There is a special limitation for heavy SUVs with gross vehicle weight ratings (GVWR) between 6,001 and 14,000 pounds. If your heavy SUV was put into service during 2022, you may be able to claim 100% of the first-year bonus depreciation percentage.

For tax years starting in 2023, though, the maximum Sec 179 deduction is $28,900. First-year bonus depreciation has been decreased to 80%. This percentage is expected to drop further each year leading up to 0% in 2027.

Exception: These percentage cutbacks will be delayed by one year for certain assets with longer production periods. 

Limitations for passenger autos 

For federal tax purposes, passenger vehicles are defined as cars, light trucks, and light vans. 

Special depreciation limits apply to these vehicles undo luxury auto depreciation rules. 

The maximum luxury auto deductions for used and new passenger autos placed in service during 2023 are:

  • $12,200 for Year 1 ($20,200 if bonus depreciation is claimed)
  • $19,500 for Year 2
  • $11,700 for Year 3
  • $6,960 for Year 4 and thereafter until fully depreciated

Of course, these allowances assume 100% business use and will be further adjusted for inflation in future years.

Heavy vehicles may come with an advantage

Heavy SUVs, pickups, and vans (those with GVWRs above 6,000 pounds) are considered transportation equipment and, as such, are considered exempt from the luxury auto depreciation limitations.

However, at least half of their use must be for business purposes to be eligible for the Sec. 179 deductions and first-year bonus depreciation we discussed above.

If these vehicles are used a significant amount for personal use, their cost must be depreciated using the straight-line method over the course of six tax years.

Otherwise, the business-use percentage of the vehicle’s cost must be depreciated using the straight-line method, and it’ll take six tax years to fully depreciate the cost.

Questions about your business taxes? Smolin can help.

The depreciation rules for business assets can be confusing, but working with a professional can help you get the maximum depreciation tax breaks for your business.

If you want to learn more about what to expect for your specific assets, contact the friendly tax professionals at Smolin.

Understanding Deferred Taxes
Understanding Deferred Taxes 1275 750 smolinlupinco

Navigating deferred taxes can be a confusing process, and the accounting rules for reporting deferred taxes can sometimes seem arbitrary and nonsensical when viewed through the lens of real-world economics. Here’s a brief article to help simplify this complex subject.

What are deferred taxes?

Companies are required to pay income tax on taxable income as defined by the IRS. On their Generally Accepted Accounting Principles (GAAP) financial statements, however, companies record income tax expense based on accounting “pretax net income.” 

In any particular year, your taxable income (for federal income tax purposes) and pretax income (as reported on a GAAP income statement) may differ substantially. Depreciation expense is typically the reason for this temporary difference.

The IRS allows companies to use accelerated depreciation methods to lower taxes that are paid in the early years of an asset’s useful life. Many companies may also choose to claim Section 179 deductions and bonus depreciation for the year an asset is put into service. 

An alternative route that many companies take for GAAP reporting purposes is to use straight-line depreciation. At the beginning of an asset’s useful life, this typically causes taxable income to be dramatically lower than GAAP pretax income. That said, as the asset gets older, this temporary depreciation expense is reversed. 

Understanding differing depreciation methods

Using differing depreciation methods for tax and accounting purposes causes a company to report deferred tax liabilities. In simple terms, this means that by claiming higher depreciation expense for tax purposes than for accounting purposes, the company has momentarily reduced its tax bill but must make up the difference in later tax years. 

Deferred tax assets can come from other sources like operation loss carryforwards, tax credit carryforwards, and capital loss carryforwards.

How should deferred taxes be reported on financials?

When a company’s pretax and taxable incomes differ, it is required to record deferred taxes on its balance sheet. 

This can go one of two ways. If a company pays the IRS more tax than an income statement reflects, it records a deferred tax asset for the future benefit the company is entitled to receive. If the opposite occurs and the company pays less tax, it must record a deferred tax for the additional amount it will owe in the future.

Like other liabilities and assets, deferred taxes are classified as either current or long-term. 

No matter their classification, though, deferred taxes are recorded at their cash value (that is, with no consideration of the time value of money). Deferred taxes are also based on current income tax rates. The company can revise its balance sheet, in which case change flows through to the income statement if tax rates change.

Unlike deferred tax liabilities which are recorded at their full amount, deferred tax assets are offset by a valuation allowance that reflects the potential of an asset expiring before the company can utilize it. Determining the amount of deferred tax valuation allowance to log is at the discretion of management is highly subjective. It’s important to note that all changes to this allowance will flow through to the company’s income statement.

Today, or later on down the line?

For financial statement users, it’s critical not to lose sight of deferred taxes. A company with significant deferred tax assets may be able to reduce its tax bill in the future and save much-needed cash on hand by claiming deferred tax breaks. 

On the other hand, a company with considerable deferred tax liabilities will have already taken advantage of tax breaks and may need additional cash on hand to pay the IRS in future tax years.

Questions? Smolin can help 

Still unsure of how deferred taxes might affect your business? If you would like to discuss any of these issues or gain a better understanding of tax rules for businesses, our CPAs can help. Contact us to get started. 

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