IRS Publication 463, Leasing a Car

If you lease a car, truck, or van that you use in your business, you can use the standard mileage rate or actual expenses to figure your deductible expense. This section explains how to figure actual expenses for a leased car, truck, or van.

Deductible payments. You can deduct the part of each lease payment that is for the use of the car in your business. You cannot deduct any part of a lease payment that is for personal use of the car, such as commuting.

You must spread any advance payments over the entire lease period. You cannot deduct any payments you make to buy a car, even if the payments are called lease payments.

If you lease a car for 30 days or more, you may have to reduce your lease payment deduction by an "inclusion amount."

Inclusion Amounts

If you lease a car that you use in your business for a lease term of 30 days or more, you may have to include an inclusion amount in your income for each tax year you lease the car. To do this, you do not add an amount to income. Instead, you reduce your deduction for your lease payment. (This reduction has an effect similar to the limit on the depreciation deduction you would have on the car if you owned it.)

The inclusion amount is a percentage of part of the fair market value of the leased car multiplied by the percentage of business and investment use of the car for the tax year. It is prorated for the number of days of the lease term in the tax year.

The inclusion amount applies to each tax year that you lease the car if the fair market value (defined below) of the car when the lease began was more than the amounts shown in the following table.

Year Lease Began Fair Market Value*
2003 $18,000
1999-2002 15,500
1997-1998 15,800
1995-1996 15,500
1994 14,600
1993 14,300
1992 13,700
1991 13,400
1987-1990 12,800
* For 2003, the fair market value for trucks and vans is $18,500 and for electric cars it is $53,000.

Fair market value. Fair market value is the price at which the property would change hands between a buyer and a seller, neither having to buy or sell, and both having reasonable knowledge of all the necessary facts. Sales of similar property around the same date may be helpful in figuring the fair market value of the property.

Figure the fair market value on the first day of the lease term. If the capitalized cost of a car is specified in the lease agreement, use that amount as the fair market value.

Figuring the inclusion amount. Inclusion amounts are listed in Appendix A for cars, in Appendix B for trucks and vans, and in Appendix C for electric cars leased after August 5, 1997. If the fair market value of the car is $100,000 or less, use the appropriate appendix (depending on the year you first placed the car in service) to determine the inclusion amount. If the fair market value is more than $100,000, see the Revenue Procedure(s) identified in the footnote of the appendices for the inclusion amount. Revenue Procedures are available at most IRS offices and many local libraries.

For each tax year during which you lease the car for business, determine your inclusion amount by following these three steps.

  1. Locate the appendix that applies to you. To find the inclusion amount, do the following.

    1. Find the line that includes the fair market value of the car on the first day of the lease term.

    2. Go across the line to the column for the tax year in which the car is used under the lease to find the dollar amount. For the last tax year of the lease, use the dollar amount for the preceding year.

  2. Prorate the dollar amount from (1)(b) for the number of days of the lease term included in the tax year.

  3. Multiply the prorated amount from (2) by the percentage of business and investment use for the tax year. This is your inclusion amount.

Example. On January 17, 2002, you leased a car for 3 years and placed it in service for use in your business. The car had a fair market value of $32,250 on the first day of the lease term. You use the car 75% for business and 25% for personal purposes during each year of the lease. Assuming you continue to use the car 75% for business, you use Appendix A-6 to arrive at the following inclusion amounts for each year of the lease:

Tax Year Dollar Amount Proration Business Use Inclusion Amount
2002 $80 349/365 75% $76
2003 175 365/365 75% 131
2004 260 366/366 75% 195
2005 260 16/365 75% 9

For each year of the lease that you deduct lease payments, you must reduce your deduction by the inclusion amount computed for that year.

Leased car changed from business to personal use. If you lease a car for business use and, in a later year, change it to personal use, follow the rules explained earlier under Figuring the inclusion amount. For the tax year in which you stop using the car for business, use the dollar amount for the previous tax year. Prorate the dollar amount for the number of days in the lease term that fall within the tax year.

Example. On August 16, 2002, Will leased an electric car with a fair market value of $58,600 for 3 years. He used the car exclusively in his own data processing business. On November 5, 2003, Will closed his business and went to work for a company where he is not required to use a car for business. Using Appendix C-6, Will computed his inclusion amount for 2002 and 2003 as shown in the following table and reduced his deductions for lease payments by those amounts.

Tax Year Dollar Amount Proration Business Use Inclusion Amount
2002 $59 138/365 100% $ 22
2003 128 309/365 100% 108

Leased car changed from personal to business use. If you lease a car for personal use and, in a later year, change it to business use, you must determine the car's fair market value on the date of conversion. Then figure the inclusion amount using the rules explained earlier under Figuring the inclusion amount. Use the fair market value on the date of conversion.

Example. In March 2001, Janice leased a car for 4 years for personal use. On June 1, 2003, she started working as a self-employed advertising consultant and started using the leased car for business purposes. Her records show that her business use for June 1 through December 31 was 60%. To figure her inclusion amount for 2003, Janice obtained an appraisal from an independent car leasing company that showed the fair market value of her 2001 car on June 1, 2003, was $18,650. Using Appendix A-7, Janice computed her inclusion amount for 2003 as shown in the following table.

Tax Year Dollar Amount Proration Business Use Inclusion Amount
2003 $ 12 214/365 60% $4

Reporting inclusion amounts. For information on reporting inclusion amounts, employees should see Car rentals under Completing Forms 2106 and 2106-EZ in chapter 6. Sole proprietors should see the instructions for Schedule C (Form 1040) (pdf) and farmers should see the instructions for Schedule F (Form 1040) (pdf).

 

Information courtesy of the Internal Revenue Service.