Automobile Deductions with Rentals

By Jason Watson, CPA
Posted Saturday, September 7, 2024

This section is a mini me of our various rental property depreciation sections. Here is the collapsed summary-

A question we entertain on the daily is “I want to save taxes. Should I have the business / rental property buy a car?” Our auto-attendant replies with, “Do you need a car?” If you answer with “Yes” the auto-attendant replies with, “Hold please.” If your “Yes” is not quick or mumbled, or if there is any recognition of hesitation, the auto-attendant is unhappy.

Kidding aside, there are only a few questions you need to ask yourself when considering an automobile purchase in connection with your rental property or small business. Are you the type of person who buys new? How long do you typically keep your cars? Is the car 100% business use? How many miles do you plan to drive? There is a decision tree section that follows on page xx.

Back up for a bit. Remember our previous discussions about tax deductions, and how only a fraction of the money you spend is returned to you? So, back to our auto-attendant, “Do you need a car?” If the answer is “Yes” because your bucket of bolts is getting exceedingly dangerous, then Yes, buy a much-needed car out of a sense of safety. If the answer is “Not really, but I want to save taxes,” then don’t.

Two rules to live by-

• Cash is King (keep it!)

• Depreciation is a tax deferral not a tax avoidance system (typically)

There might be some other external forces at play. For example, if you need a car next year but your income is ridiculously and unusually high in the current tax year, then reducing your income now makes sense. Again, tax modeling and planning is critical.

We use car and automobile interchangeably. Ok, you’ve determined that an automobile purchase should be in your near future, now what? There are five scenarios in descending order of elegance-

• You Own the Automobile, Take a Mileage Deduction (clean and elegant)

• You Own the Automobile, Take Actual Expenses Deduction (a bit more recordkeeping)

• Rental Property Activity Owns the Automobile (mixed bag)

• You Own the Automobile, Get Reimbursed by the Mile (not common in rental properties)

• You Own the Automobile, Lease it Back to Your Business (unnecessarily complicated)

Before we jump into these various situations, we need to revisit rental property travel deductions. We expand on this in an earlier section, but here is a summary of the various issues and considerations-

• Travel to your rental property must be meaningful, ordinary and necessary.

• Travel between work locations is generally deductible. The power of the home office with your rental property activities is critical. A home office is simply another work location, where your commute is now from the bedroom to the basement.

• Travel away from your home (tax home) in pursuit of a trade or business is generally deductible. Your tax home is the location where you earn your primary income.

• Travel costs with research, start-up and acquisition have several rules where they might be deductible, they might not be deductible, or they might be added to the purchase price of the rental property and depreciated accordingly.

• Travel expenses during repairs and improvements also have various rules depending on the classification of repair versus improvements.

As mentioned above, see our rental property travel deductions section for a deeper look into these issues.

You Own the Automobile, Take Standard Mileage Deduction

This is the class favorite for two big reasons- first, the ease of simply recording mileage with a mileage log (paper or phone app) is appealing. Date, beginning odometer, ending odometer and business purpose. Simple!

The other reason is tax arbitrage. According to AAA, the cost to own and operate a 2022 small sedan was 54 cents per mile assuming 15,000 miles driven per year. However, this includes all sorts of fixed costs as well such as insurance, registration and finance. In other words, regardless of the miles driven, you will incur some fixed expenses. Even if you don’t finance, you still have a cost to use your equity (i.e., paying cash).

Back to the tax arbitrage. The data above is for a new automobile, and of the 54 cents above, 24 cents is depreciation. However, automobile depreciation is not linear. If you purchased a 5-year-old nicely used Honda Accord, its annual depreciation is tiny as compared to a new one. Also, depreciation is a cashless expense in a sense. Sure, cash is being spent on the automobile itself, but if viewed as a sunk cost, then depreciation is cashless.

What are we getting at? A lightly used small sedan will operate for a lot less than 54 cents per mile although the IRS allows you to deduct 67 cents per mile for the 2024 tax year. Let’s assume that you drive 6,000 miles for the rental property, and your true operating costs are 24 cents per mile. This is a difference of 43 cents, and at 6,000 miles this equates to $2,580 as a rental property expense.

Sidebar: You are technically supposed to reduce the cost basis of your automobile by the depreciation portion of the mileage deduction. This in turn could cause a taxable gain should you sell your automobile for more than its original cost basis after being reduced for the mileage depreciation. Most tax professionals don’t know this, and certainly most taxpayers don’t know this either but there you go.

You Own the Automobile, Take Actual Expenses Deduction

There might be times where actual expenses provide for a better tax deduction. However, as we’ve just shown with the mileage deduction calculation above, your automobile would need to operate at a high cost. This is not totally uncommon with large work trucks and SUVs. According to the same AAA data as above, half-ton trucks operate for 86 cents a mile at 15,000 annual miles.

There are two downsides to taking the actual expense deduction. First, you must track all miles driven, both personal and business. This is necessary to support your business use percentage since it will be applied to your actual expenses.

For example, you drive 15,000 miles total and 6,000 were for the rental properties, or about 40%. This 40% is then applied to the costs of insurance, registration, maintenance, fuel, new tires, etc.

The other downside is that once you use actual expenses for a tax year, you must continue to use actual expenses for the remainder of that automobile’s use in the activity (rental property use, small business use, etc.).

Rental Property Activity Owns the Automobile

This one is tough since you would need to demonstrate at least 50% business use in the rental property or series of rental properties to leverage the most tax benefit. You own a single-family home as a long-term rental and would like to take advantage of the electric vehicle credit on that shiny Cybertruck. This idea might not work, and it also might cause an aggressive eye roll from your spouse.

Can you support at least 50% business use? Sure, but why have a $100,000 automobile sitting around most days not being driven?

What if the rental property is a short-term rental? What if your rental property is an 8-unit mini apartment building? What if you purchased four rental properties in one year that needed a lot of minor repairs?

As you can see there are a zillion different facts and circumstances where you could justify having your rental property activity or activities own the automobile. From there, you need to ensure it makes tax sense. As we discussed in the beginning of this chapter, the value of a tax deduction is substantially less than the cash spent. However, with automobiles that degrade in value, at times it makes sense for this value degradation to be a tax deduction as well.

You Own the Automobile, Lease It Back to Your Rental

If you owned and operated a landscaping business, you might own the heavy equipment personally, and lease it back to the business. This is very common and is considered a self-rental.

The same thing can be accomplished with your automobile. You would lease a car that you own back to your business. This is not considered the same as the business leasing the car from a dealer. This is creating a self-rental arrangement between you and your business. Why would you want to do that?

The usual reason- it might prove to be a better tax position since you are reducing the income of your LLC which is subjected to self-employment taxes. However, rental properties and real estate investments are not subject to Social Security and traditional Medicare taxes unless they are operated like a hotel.

As such, this automobile strategy is uncommon in a conventional rental property environment. We mention it in case your bartender or produce clerk is compelled to share their tax reduction prowess.

Pile On Those Automobile Expenses

At times you might want to skip tracking your mileage and rental property travel expenses because you are unable to deduct passive activity losses. For example, your W-2 income is too high, and the rental property does not qualify as a short-term rental. Therefore, you tell yourself, “Why bother? My rental losses don’t help me.”

Keep in mind that unallowed losses are not lost forever. Rather, they carried over year after year on Form 8582 Passive Activity Loss Limitations, and can be used when you have rental profits or when you sell the rental property. As such, track that mileage or travel expense, and pile on!

Who Pays for Gas?

With anything that is mixed use between personal and business or rental property, the asset is owned by you the human. Therefore, personal funds should be used to pay for all related costs and payments. The common examples are automobile, cell phone and home office expenditures.

Mileage Log

For the mileage deduction and actual expense deduction, you need a mileage log. This includes date, beginning odometer, ending odometer and business purpose. Most rental property owners use a smartphone app to keep track of the miles. Sure, it is simple to peg the number of round trips or something similar, but there are a lot of other miles driven in connection with the rental property (Lowe’s, landfill, Target, bank, etc.).

Keep in mind that the IRS wants corroborating evidence to support your mileage logs, so keep those Jiffy Lube receipts or other service records showing odometer readings near the beginning and end of the year (so extrapolation can occur). Just whippin’ out a pretty color-coded spreadsheet during an IRS examination is not enough.

Finally, mileage logs must be maintained in real time or what the courts like to call contemporaneous records.