Deducting Vehicle Lease Payments

April 13, 2006

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If you lease a vehicle for your business, you can generally use the actual cost method of computing your vehicle expenses. Then, you can deduct each lease payment as a rental expense. However, when business use of a leased vehicle is less than 100 percent, the rental deduction is scaled down in proportion to the personal use.

If you use a leased car 75 percent for business, and 25 percent for personal purposes and commuting, you can deduct only 75 percent of the lease payments. The percentage of use for business is determined using your mileage records.

Moreover, if a vehicle with a fair market value in excess of approximately $15,200 (for 2006) is leased, you must add back an additional amount (i.e., subtract it from your otherwise deductible amount) to offset a portion of the lease payments. This rule was enacted to prevent individuals from avoiding the luxury car depreciation limits that apply to purchased vehicles. The amounts that must be added into your income are called "inclusion amounts" and are taken from a price-based table issued annually by the IRS.

These tables are published in IRS Publication 463, Travel, Entertainment, Gifts, and Car Expenses. Since 2003, there is also a separate table for leased trucks and vans.

To use the table, find the value of your car on the first day of your lease term (or on the day you converted your personal car to business use) in the first column, and read across the line to the column that matches the year of your lease to find the dollar value to be included. Then prorate the dollar amount from the table for the number of days of the lease term included in your tax year, and multiply the prorated amount by your percentage of business use for the year (as calculated by using your mileage records).

Let's say that on April 1, 2006, you leased a car with a fair market value of $31,700 for a four-year term. Assuming that you are a calendar-year taxpayer and used the car only for business, your includible amount for 2006 is $82.12 (275/365 x $109). Your includible amounts for 2007, 2008, and 2009 are $238, $353, and $422, respectively. For 2010, your includible amount is $119.59 (90/365 x $485 (the dollar amount for the preceding year for the last year of the lease)).

Optional standard mileage rate. Note that if you are leasing your car or truck, as of 1998 you can elect to use the standard mileage rate to compute your auto expenses, provided that you use this method for the entire period of the lease. If your lease began before 1998, you would need to use the SMR for the remainder of the lease term.