When a vehicle is used in a trade or business, the expenses to own and operate the vehicle are deductible in most situations. It is common, however, for vehicles to be driven for both business and personal use. In this case, the business owner must divide these expenses, usually by miles driven for each purpose.
To deduct expenses, the first requirement is to show that the vehicle was used for business - usually fulfilled by keeping adequate written records. "Adequate records" may include account books, diaries, logs, statements of expense, trip sheets or similar records. In combination, these will verify expenditures. Although business expense records do not have to be on paper, oral evidence alone may not have sufficient credibility in an audit.
There is a substantiation safe harbor regulation for vehicles used directly in connection with the business of farming that allows vehicle expenses to be deducted without trip-by-trip substantiation. Under this safe harbor, qualified business use is generally considered to be 75 percent. To qualify for the safe harbor, the vehicle must be owned or leased by an agricultural producer and used during most of a normal business day in connection with the business of farming. The business of farming is cultivating land or raising or harvesting any agricultural or horticultural commodity. It also includes the raising, shearing, feeding, caring for, training and management of animals.
Another option to substantiate business use is by the sampling method. When only one person in the business operates the vehicle, records documenting business use can be maintained for only a portion of the taxable year if the owner can demonstrate by other evidence that the period(s) for which an adequate record is maintained is representative of the use for the entire year. If more than one person operates the vehicle for any portion of a year, the sampling method is disallowed.
Once the business use of a vehicle is established, there are a couple of ways to deduct expenses. Option one is to use actual expenses and the second is using a standard mileage rate. Actual expenses incurred usually include, but are not limited to, such items as depreciation, interest, fuel, tires, repairs, licenses and insurance. The standard mileage rate for 2008 is 50.5 cents per mile, up two cents from 2007, for business purposes and is used in lieu of actual expenses.
If a business owner wants to use the standard mileage rate for a vehicle he or she owns, the choice must be made in the first year the vehicle is available for use in the business. In later years, a business owner can choose to use actual expenses if that method offers a larger deduction. If a business owner wants to use the standard mileage rate with a leased vehicle, it must be used for the entire lease period. When using the standard mileage rate to deduct vehicle expenses, the vehicle must be depreciated using the straight line method of depreciation rather than the Modified Accelerated Cost Recovery System (MACRS). In addition, a Section 179 expensing election is not allowed when using the standard mileage rate. In 2007, the Section 179 election allows up to $125,000 of capital purchases, such as farm vehicles with gross vehicle ratings of over 6,000 pounds, to be deducted in the year of purchase. In 2008, the Section 179 election will be increased to $128,000. The election must be made in the year of purchase. However, a business owner cannot deduct more than the taxable income from the active conduct of any trade or business during the year under Section 179. In addition, a vehicle used for personal purposes cannot qualify for the Section 179 deduction in a later year when its use changes to business.
As with any business expense, good recordkeeping is the key for proper substantiation. Good records will allow you and/or your tax preparer to analyze the best choice to deduct the expenses incurred each year for the business use of your vehicle.