First year depreciation on a new car

When your business adds cars to its fleet, it has to be content with two different types of depreciation. The Internal Revenue Service lets you depreciate cars and trucks that you buy for your business, although its rules are relatively complicated and usually limit the value of your depreciation deduction. At the same time, the market saps value from your car, frequently depreciating it at a completely different rate than what the Internal Revenue Service allows.

IRS Depreciation Rates

The IRS lets you depreciate cars over a five-year period. You can opt to use straight-line depreciation, which would write off 20 percent of the car's cost basis each year. Alternately, you can use accelerated depreciation and, as of the date of publication, bonus depreciation, which could let you claim as much as 60 percent of the car's value in the first year. Because these rules are complicated and prone to frequent change, have a certified public accountant help you calculate your depreciation.

IRS Depreciation Limits

Unfortunately, you probably can't depreciate your business's car as quickly as you think. To the IRS, any car under 6,000 pounds is subject to luxury auto price limitations that reduce the amount of the car's value that you can depreciate. While the limits vary depending on your exact depreciation method and situation, you're generally limited to writing off no more than the Section 280F limit. The Tax Cuts and Jobs Act substantially increased the dollar limits on the annual depreciation of automobiles but generally, you're going to be limited to deductions between $18,000 and $5,760 annually on a sliding scale, depending on when the vehicle was placed into service.

Given that the average new car in 2018 cost $35,285, there's a good chance that the fleet vehicle you're buying is a luxury car in the IRS' eyes. These limitations usually do not, however, apply to truck-based vehicles with gross weights over 6,000 pounds, but it's still best to talk to a CPA.

Real World Depreciation

Regardless of what the IRS says, your ability to resell your business's cars is set by the market. While different cars depreciate at different rates, it's a good rule of thumb to assume that a new car will lose approximately 20 percent of its value in the first year and 15 percent each year after that until, after 10 years, it's worth around 10 percent of what it originally cost. This means that a $30,000 vehicle will be worth $24,000 after the first year, $20,400 after the second year and $17,340 after the third year.

Recapture Tax

If you sell a property at a loss but for more than its depreciated value, the IRS will tax you on the extra value. Businesses that buy relatively valuable cars and trade them in frequently usually won't have to deal with this, but if you buy fleet cars and keep them for a while, it's possible that your business could end up with a fully depreciated car for which it gets a few thousand dollars. All of those sale proceeds would be taxable, unless you sell your car in a 1031 tax-deferred exchange and carry your basis forward.

What is car depreciation?

Car depreciation is the difference between the car’s value when you buy it and the amount you receive when you sell or trade it in. Depreciation is one of the biggest overlooked costs when it comes to cars, as a vehicle begins to lose value as soon as it leaves the dealership. Cars typically lose the most value during the first year of being owned, but this depreciation slows after around three years. While every vehicle is subject to depreciation, the rate of value loss varies greatly between makes and models.

In leasing, the residual value of a vehicle is how much it is worth once the agreement ends. With contract hire, you don’t need to worry about depreciation, as your monthly payments take into account the car’s retail price, predicted loss in value, mileage, and condition over the course of your contract. If a car is worth £20,000 new and your contract is for three years with a 10,000 mileage allowance per annum, the finance company may predict the car will be worth £6,500 once the agreement ends. Therefore, you’ll need to pay £4,500 per year over three years.

How much does a car depreciate each year?

The rate of depreciation typically slows with age. On average, a car depreciates by 15-25% in the first year and up to 60% over three years, assuming it travels 10,000 miles annually. A new car depreciates faster than a used model, losing 10% of its value as soon as it is driven off the lot. For example, if you purchase a new car for £33,556, it will lose £3,356 in value as soon as you drive it and around a further £17,780 over the next three years.

This loss in value varies between models – while an Audi may depreciate by 40% on average over three years, a Porsche may lose just 25% over the same period. The manufacturer, model, size, condition and year of the car are all factors that affect the depreciation rate of a car. For example, if the manufacturer has a reputation for reliable, strong and durable vehicles, this can help withstand depreciation.

What factors affect depreciation?

While 99% of cars depreciate, there are some factors that can dramatically impact the amount that a vehicle loses in value. These include:

Vehicle age

The age of a car is the biggest factor in depreciation, as new cars depreciate the fastest. Most brand-new vehicles lose around 10% of their value as soon as they’re driven from the dealership and a further 10-20% before the end of the first year. After that, the depreciation levels out to between 15% and 25% per year, for an average loss of 60% by the third year. Because vehicles depreciate the most in the first year, buying a used car can save you roughly 20-30%, as value loss averages 17.5% after the first year.

Instead of buying a new or used car, you could choose to lease. With contract hire, there’s no need to take vehicle age into consideration as the cost of depreciation is included in the monthly payments, based on the car’s expected residual value.

Supply and demand

The higher the demand for a car, the less it will depreciate over time. Conversely, if there are more sellers than buyers, resale value may go down. Even the colour of a car will affect the resale value – although a uniquely coloured car may appeal to you, it will narrow down the amount of potential buyers interested in the car when you come to sell. Black, white or silver cars are the best choices to reduce depreciation.

Another factor to take into consideration is the time of year you choose to sell. For example, you’ll get less for a convertible if you decide to sell during the winter, and less for a 4×4 in summer. Furthermore, if the manufacturer just updated or discontinued your model, the resale value will go down unless it’s a particularly rare or desirable car.

Engine type

Although fuel efficiency alone doesn’t determine depreciation, MPG is a key influencer in resale value. Larger vehicles and larger engines require more fuel more frequently, meaning they suffer more from depreciation. Diesel vehicles tend to depreciate slower than petrol cars as they are generally more fuel efficient, with petrol-engine saloons tending to suffer the most. For example, a Ford Focus 1.0-litre petrol Ecoboost with Zetec trim costs £12,000 less than a 1.5 TDCi 120 model in the same spec. Despite this, the diesel model will be worth £1,050 more than its petrol counterpart after three years.

Mileage

The average mileage is around 10,000 miles a year. Mileage is one of the biggest factors that affects the value of a car – the more miles, the more wear and tear to the vehicle and the less a car is worth over time. If a new car has an RRP of £20,000 and is sold with 40,000 miles on the clock a few years later, it would be worth around 40% less at resale based on mileage alone.

You don’t have to worry about mileage and depreciation when it comes to leasing, as the payments are based on an annual mileage allowance as stipulated in your contract. It’s vital to choose a mileage allowance that accurately reflects your requirements, as you’ll be subject to excess charges if you exceed your mileage limit.

General condition

The general condition of a car will affect depreciation, as damage to the bodywork, interior and exterior will reduce the resale value. Modifications like a new stereo, spoiler or alloy wheels can also impact how much a car is worth, as most buyers will prefer purchasing the model in its original condition. It’s important to keep a complete service history of your car, as regular maintenance and proof of your car’s condition will reduce depreciation

How to reduce the effects of depreciation

Any depreciation values given are only estimations of what the residual value of your car will be by the time it comes to replacing it. If you want to help your car keep as much of its value for as long as possible, some of the simple things you can do include:

Take out GAP insurance

GAP insurance covers the depreciation of your car. It’s designed to cover the difference between what your car insurance provider pays out and what you paid or still owe on the car, depending on the type of policy. For example, if your car is worth £10,000 and is written off after three years, the insurance will pay out around £5,000 – the market value of the car at the time of the claim, based on a 50% depreciation rate. With GAP insurance, you’d get the full value back – £5,000 from the insurance policy and the other £5,000 from GAP cover.

Lease rather than buy

With leasing there’s no concerns about the car’s depreciation as you don’t own the car, so it’s not your responsibility. The payments you make when leasing cover the difference between the value of the car new and the anticipated residual value once you hand it back – in other words, the depreciation. Even if market conditions lead to your vehicle’s depreciation being greater than predicted, the finance company absorbs this loss – not you. You often find that you pay less over a fixed-term contract than you would if you’d purchased the car and sold it on after the same time period.

Summary

There are many things you need to factor in when working out how to limit the value loss of your next car. However, it’s clear that leasing has a lower financial outlay when it comes to depreciation than buying.

If you’re looking for a new lease vehicle, contact our dedicated team today to discuss your requirements.

With leasing there’s no concerns about the car’s depreciation as you don’t own the car, so it’s not your responsibility. The payments you make when leasing cover the difference between the value of the car new and the anticipated residual value once you hand it back – in other words, the depreciation. Even if market conditions lead to your vehicle’s depreciation being greater than predicted, the finance company absorbs this loss – not you. You often find that you pay less over a fixed-term contract than you would if you’d purchased the car and sold it on after the same time period.

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