Depreciation Deduction

Gregory J. Cook, EA, CPA+ Accredited Tax Advisor Past President Alabama Society of Enrolled Agents Past President Alabama Association of Accountants

Automobile Depreciation


Improvements - A major improvement to a car is treated as a new item of 5-year recovery property. It is treated as placed in service in the year the improvement is made. It does not matter how old the car is when the improvement is added. Follow the same steps for depreciating the improvement as you would for depreciating the original cost of the car.

However, you must treat the improvement and the car as a whole when applying the limits on the depreciation deductions. Your car’s depreciation deduction for the year (plus any section 179 deduction, special depreciation allowance, and depreciation on any improvements) cannot be more than the depreciation limit that applies for that year.

Car trade-in - If you traded one car (the “old car”) in on another car (the “new car”), there are two ways you can treat the transaction.

1. You can elect to treat the transaction as a tax-free disposition of the old car and the purchase of the new car. If you make this election, you treat the old car as disposed of at the time of the trade-in. The depreciable basis of the new car is the adjusted basis of the old car (figured as if 100% of the car’s use had been for business purposes) plus any additional amount you paid for the new car. You then figure your depreciation deduction for the new car beginning with the date you placed it in service. You make this election by completing Form 2106, Part II, Section D. This method is explained later, beginning at Effect of trade-in on basis.

2. If you do not make the election described in (1), you must figure depreciation separately for the remaining basis of the old car and for any additional amount you paid for the new car. You must apply two depreciation limits (see Depreciation Limits, later). The limit that applies to the remaining basis of the old car generally is the amount that would have been allowed had you not traded in the old car. The limit that applies to the additional amount you paid for the new car generally is the limit that applies for the tax year, reduced by the depreciation allowance for the remaining basis of the old car.

You must use Form 4562, Depreciation and Amortization, to compute your depreciation deduction. You cannot use Form 2106, Part II, Section D. This method is explained in Publication 946.

If you elect to use the method described in (1), you must do so on a timely filed tax return (including extensions). Otherwise, you must use the method described in (2).

Effect of trade-in on basis - The discussion that follows applies to trade-ins of cars in 2006, where the election was made to treat the transaction as a tax-free disposition of the old car and the purchase of the new car. For information on how to figure depreciation for cars involved in a like-kind exchange (trade-in) in 2006, for which the election was not made, see Publication 946 and Temporary Regulations section 1.168(i)-6T(d)(3).

Traded car used only for business - If you trade in a car that you used only in your business for another car that will be used only in your business, your original basis in the new car is your adjusted basis in the old car, plus any additional amount you pay for the new car.

Example 1. Paul trades in a car that has an adjusted basis of $5,000 for a new car. In addition, he pays cash of $20,000 for the new car. His original basis of the new car is $25,000 (his $5,000 adjusted basis in the old car plus the $20,000 cash paid). Paul’s unadjusted basis is $25,000 unless he claims the section 179 deduction, or has other increases or decreases to his original basis.

Example 2. In October 2003, Marcia purchased a car for $26,000 and placed it in service for 100% use in her business. Marcia did not claim a section 179 deduction but she did claim the special depreciation allowance. Marcia’s unadjusted basis for the car was $15,290 ($26,000 - $10,710 (50% special depreciation allowance up to the maximum amount allowed)). For 2003 through 2005, Marcia figured her depreciation deduction using the MACRS depreciation chart for those years.


In September 2006, Marcia traded that car in and paid $14,200 cash for a new car to be used 100% in her business. Marcia is allowed one-half of the MACRS depreciation amount figured for 2006 for her old car.

Traded car used partly in business - If you trade in a car that you used partly in your business for a new car that you will use in your business, you must make a “trade-in” adjustment for the personal use of the old car. This adjustment has the effect of reducing your basis in your old car, but not below zero, for purposes of figuring your depreciation deduction for the new car. (This adjustment is not used, however, when you determine the gain or loss on the later disposition of the new car. See Publication 544, Sales and Other Dispositions of Assets, for information on how to report the disposition of your car.)

To figure the unadjusted basis of your new car for depreciation, first add to your adjusted basis in the old car any additional amount you pay for the new car. Then subtract from that total the excess, if any, of:

1. The total of the amounts that would have been allowable as depreciation during the tax years before the trade if 100% of the use of the car had been business and investment use, over

2. The total of the amounts actually allowable as depreciation during those years.


Example 1. In March, Mark traded his 2002 van (placed in service in June 2002) for a new 2006 model. He used the old van 75% for business and he used the new van 75% for business in 2006. Mark claimed actual expenses (including $12,756 depreciation expense total) for his old van for 2002. He did not claim a section 179 deduction for the old or the new van.


Mark paid $19,500 for the 2002 van in June 2002. He paid an additional $12,500 when he acquired the 2006 van. Mark was allowed ½ of the depreciation deduction amount (which is included in the $12,756 depreciation expense total) for his old van for 2006, the year of disposition, as explained later under Disposition of a Car. Mark does not claim the special depreciation allowance.

Example 2. Rob paid $21,000 for a new car that he placed in service in 2003. He used it partly for business in 2003 (9,600 business miles of 15,000 total miles), 2004 (12,000 business miles of 16,000 total miles), and 2005 (14,400 miles of 18,000 total miles). He used the standard mileage rate in those years to claim the business use of his car. (See “Depreciation adjustment when you used the standard mileage rate” under Disposition of a Car, later.)

Modified Accelerated Cost Recovery System (MACRS). The Modified Accelerated Cost Recovery System (MACRS) is the name given to the tax rules for getting back (recovering) through depreciation deductions the cost of property used in a trade or business or to produce income.

The maximum amount you can deduct is limited, depending on the year you placed your car in service.

Recovery period. Under MACRS, cars are classified as 5-year property. You actually depreciate the cost of a car, truck, or van over a period of 6 calendar years. This is because you car is generally treated as placed in service in the middle of the year and you claim depreciation for one-half of both the first year and the sixth year.

If you dispose of a car, you may have a taxable gain or a deductible loss.