Five Tax Breaks for Drivers

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High gas Prices. Rising auto-insurance rates. Expensive repairs. Wouldn't it be nice to find a way to reduce the costs of car ownership?

One way to do so is to take advantage of the auto-related tax breaks offered by Uncle Sam. The strategies outlined below could save you hundreds each year — and are a whole lot more convenient than hitchhiking to work.

1. Use Tax-Deductible Financing
Homeowners who finance their vehicle with a home-equity line of credit (HELOC) or a home-equity loan can deduct the loan interest from their taxes. In today's environment, that's an awfully good deal.

Right now, the interest rate on a $30,000 HELOC is a mere 4.71%, according to Bankrate.com. For someone in the 28% bracket, that would translate into a 3.5% loan. Keep in mind, however, that the rate is variable, which means that as the Federal Reserve raises interest rates, the rates on those loans will rise. Home-equity loans offer slightly higher fixed rates. (The national average is 6.99% right now, according to Bankrate.com.) The tax-adjusted rate of a 6.99% loan is in the 5% to 5.5% range, depending on the tax bracket, says Bankrate.com's senior financial analyst Greg McBride. Currently, the average car loan sits at 7.4%.

2. Go Green
Hybrid cars do more than just help the environment. They can also add a little green to your wallet.

In 2004, consumers who buy a qualified hybrid car — such as a Toyota Prius, Honda Civic or Ford Escape — are eligible for a $1,500 tax deduction. But interested consumers should act fast: The IRS is phasing out the deduction by 2007. In 2005, it will be worth $1,000; in 2006, it shrinks to just $500. There is, however, the possibility that an energy bill currently stalled in Congress will pass, reinstating some sort of tax savings for 2007.

3. Write Off the Miles
Sadly, you can't deduct your daily commute. (That is, unless you're lucky enough to have access to flexible spending account that allows you to set aside pretax dollars for public transportation and parking.) But you can write off other work-related auto expenses if you're self-employed, a small-business owner or if your employer doesn't reimburse you for noncommuting driving required for your job, such as making sales calls or deliveries. If you fall into the latter category, keep in mind that you'll only be able to deduct expenses that exceed 2% of your adjusted gross income.

The easiest way to take full advantage of this tax perk is with the standard-mileage-rate method, explains Margo Reilly, an accountant with E. Slott & Co., based in Rockville Center, N.Y. For 2004, the IRS allows drivers to deduct 37.5 cents for every work-related mile, excluding commuting miles. Drivers can also claim separate write-offs for parking fees, tolls and vehicle loan interest. (If you use your vehicle for personal use 50% of the time, you can claim only 50% of the loan interest on your taxes.)

The second, more complicated option is the actual-cost method. It allows drivers to deduct just about everything related to the business use of their cars, including depreciation, insurance, registration and license fees, and repairs. The downside: Taxpayers must keep meticulous records of every expense and mile.

4. Buy a Heavy Truck
In 2003, Congress passed what's known as Section 179 — a tax code that allows small-business owners and the self-employed to write off up to $102,000 (in 2004) for the purchase of a heavy truck or SUV, provided it weighs at least 6,000 pounds. To claim the full deduction, drivers must use the vehicle for more than 50% of their business needs. Unfortunately, this perk expires in 2006, when the deduction shrinks to $25,000.

Most SUVs — even the heavy-duty ones — cost less than $102,000. But if that Cadillac Escalade puts your total business equipment bill over the limit, you could take advantage of another related tax break: a bonus depreciation of 50%. It can be used in conjunction with Section 179, but it expires at the end of 2004.

5. Donate Your Old Car
Not sure what to do with your old clunker? Consider donating it to charity. Not only will it go to a good cause, but you also get to write off the value of your car. (To take advantage of this, you'll need to itemize your deductions on Schedule A of Form 1040.) The National Kidney Foundation, for example, makes it easy by offering to pick up your vehicle, free of charge.

The IRS, however, warns that in most cases you can't write off the full Kelley Blue Book value of your vehicle. Instead, you must assess a car or truck's fair market value, which is often substantially less, says Bob Kurilko of Edmunds.com. Ignore this, and you run the risk of an audit.

To avoid sparring with Uncle Sam, get a written appraisal from a qualified appraiser and keep the receipt with your tax documents, says Kurilko. This is a requirement for any vehicle worth more than $5,000, and it's recommended for those worth less.