How to Switch from the Mileage-Rate to the Actual-Expense MethodTax Planning
Is the mileage rate sticking it to you?
Could you increase your tax deductions by switching from the IRS mileage rate to the actual-expense method? If so, you will be happy to learn you can make that switch.
This article explains when and how.
The Mileage Rate
When you choose the mileage rate, you elect out of the actual-expense method and also elect out of MACRS depreciation.
This does not mean that you are locked out forever. The IRS grants you two ways to escape from your original mileage-rate decision and switch to the actual-expense method.
Escape 1: The Early Escape
You can make an early escape out of your choice regarding the IRS mileage rate and totally undo that original decision. But you generally have to hurry to do that.
The “hurry” part means that you must amend your tax return before the original due date, including extensions.
Example. You bought a new vehicle in 2021, and when you filed your tax return on April 15, 2022, you chose the IRS mileage-rate method. Now, you realize that was a mistake. You have until 11:59 p.m. on October 17, 2022, to file an amended return and elect actual expenses, including the Section 179 deduction, bonus depreciation, and MACRS depreciation.
In other words, when you amend your return before the final extended filing date, you undo your original tax return position and replace it with the one in the amended return.
Once the final extended filing date passes (September 15 for calendar-year corporations and October 17 for individuals), your ability to undo the original return is gone.
But you can still come out ahead with the later escape.
Escape 2: The Later Escape
In the later escape, you simply switch from the IRS mileage-rate to the actual-expense method, using straight-line depreciation over the vehicle’s remaining useful life.
It’s possible to switch from the IRS mileage-rate to the actual-expense method with MACRS depreciation, but you need the consent of the IRS commissioner. Forget that. Getting consent is too expensive, too time-consuming, and too likely to face rejection.
And besides, the switch to straight-line depreciation works very well, as you’ll see.
To make the switch to the straight-line depreciation method, you need to know your vehicle’s
- adjusted basis,
- remaining useful life, and
- estimated salvage value at the end of its useful life.
Your adjusted basis is the original cost (or other basis) reduced by depreciation. Inside the IRS mileage rate is depreciation at so much a mile. For 2022, the depreciation that’s inside each 58.5- and 62.5-cent mile is 26 cents.
Example. You paid $45,000 for the business portion of your vehicle and drove it 5,000 business miles. Depreciation on the 5,000 miles is $1,300 (5,000 times 26 cents). Your adjusted business basis is $43,700 ($45,000 minus $1,300).
Your official “estimated useful life” is how long you expect to keep the vehicle. That’s easy. Say you estimate that you will keep the vehicle for three more years. So, three years is the estimated useful life at the time of your switch.
Next, you estimate your salvage value by using the Kelly Blue Book or other respected valuation guide. Here, you establish what you think you can reasonably sell the vehicle for at the end of its estimated useful life. Make sure to print or otherwise capture the valuation evidence for your tax file.
IRS grants a bonus reduction in salvage value. If you estimate your vehicle’s useful life at three years or more, you can reduce your salvage value estimate by an amount equal to 10 percent of your basis in the property.
Example. Say you estimate a salvage value of $15,000 on a vehicle with an adjusted basis of $43,700. By using the 10 percent bonus reduction in salvage value, you can reduce your estimated salvage value by $4,370, giving you a salvage value of $10,630 ($15,000 – $4,370).
Straight-line depreciation. With an adjusted basis of $43,700, and salvage value of $10,630, you are going to depreciate $33,070 ($43,700 – $10,630) over three years. Assuming there’s no change in your business mileage, your depreciation deduction for each of the three years is $11,023.
If your estimated salvage value is less than 10 percent of your adjusted basis at the time of the switch from the IRS mileage rate to actual expenses, you use the IRS salvage-value bonus to simply make your salvage value zero.
When you make the switch from the IRS mileage rate to actual expenses, you need to consider the luxury depreciation limits that apply to passenger vehicles.
The luxury depreciation limits that apply to cars, trucks, and vans placed in service during 2022 are as follows:
You must reduce the luxury limits listed above for personal use. For example, say the $11,200 limit applies and you have 80 percent business use; your 80 percent business-use depreciation limit is $8,960 ($11,200 x 80 percent).
The good news is that the business depreciation deduction denied in a year is not lost. Instead, you simply deduct the denied depreciation in a later year or as a loss at the time of sale.
Example. Your first-year depreciation deduction is $28,200, so you have $9,000 that’s not deductible in Year One. That deduction is not lost. Either it’s deferred to a later depreciation year or it’s inside your adjusted basis at the time you sell the vehicle.
Luxury Limits Don’t Apply Here
Certain pickup trucks, SUVs, crossover vehicles, and vans are exempt from the luxury limits.
The first two steps for a truck, SUV, crossover vehicle, or van to obtain an exemption from the luxury limits are for the vehicle
- to be classified by the Department of Transportation as a truck, and
- to have a gross vehicle weight rating (GVWR) greater than 6,000 pounds.
Trucks, SUVs, crossover vehicles, and vans that meet the two tests explained above are classified for tax deduction purposes as either trucks or SUVs, both of which are exempt from the luxury limits.
If your decision to use the IRS mileage rate was wrong, you can fix it.
Depending on the status of your return, you have two escapes from your wrong choice.
- In Escape 1, you can undo your bad choice by amending your tax return before the due date for its extension expires.
- In Escape 2, you can switch from the IRS mileage-rate to the actual-expense method, using straight line depreciation with a salvage value.
In Escape 1, you can use bonus depreciation and Section 179 expensing, whereas in Escape 2, you are stuck with straight-line depreciation. Either way, the news here is that, if you need to, you can switch from the IRS mileage rate to the actual-expense method.