We have seen auto dealers placing vehicles in service as loaners (or courtesy cars) with more frequency lately. There are several specific tax implications that apply.
Courtesy cars are not treated like demonstrators for tax purposes. Demonstrators are not titled to the dealer and, as such, remain a part of new vehicle inventory. They are still factored in to the LIFO calculation and are not subject to depreciation or any other type of write-down provision for income tax purposes. For use tax purposes, many states allow the tax to be based on the fair monthly rental value of the demonstrators each month.
Because courtesy cars are usually titled to the dealership, they are removed from new vehicle inventory and may be depreciated for income tax purposes. This sometimes helps to entice dealers to move vehicles to their loaner fleet to enjoy the income tax benefits. Keep in mind, though, that courtesy cars are still subject to the annual luxury auto limitation on depreciation, which at the time of this writing is $11,160 per vehicle.
Courtesy cars, unlike rental vehicles, are subject to the luxury auto limits on depreciation for income tax purposes. Passenger cars are currently limited to $11,160 in depreciation deductions in the first year. Depreciation is even more strictly limited in subsequent years. While rentals are titled to the dealership and placed in service like courtesy cars, they are specifically exempted from the luxury auto limits on depreciation. In order to meet the requirements for this exemption, a dealer must be regularly engaged in the business of renting the vehicles. This means that, if a dealer places a $50,000 Cadillac in service as a rental, he is allowed (assuming 50% bonus depreciation) to deduct $30,000 as depreciation expense in the first year. If the vehicle is placed in service as a courtesy car, the first-year depreciation on the same car is limited to $11,160.
Many states exempt rental vehicles from use tax because they meet the requirements of a resale exemption. Courtesy cars may not enjoy this exemption on use tax. We have seen states aggressively try to collect use tax on the entire MSRP of each vehicle placed in service as a courtesy car. This is an important cost to consider.
Take for example a dealer who places a fleet of ten Cadillacs (valued at $50,000 apiece) in service as courtesy cars. While he may be happy with the $111,600 in depreciation deductions, he will be disappointed with the $30,000 in use tax that he must pay (assuming a 6% use tax rate). This is especially true when you consider that the tax savings attributable to the depreciation will have to be repaid upon the ultimate sale of those vehicles – perhaps just one or two years down the road.
Keep in mind that all states differ on the taxability of courtesy cars. There are various exemptions available in many states. For example, some states exempt the vehicles that are used for warranty work, but require tax to be paid on the non-exempt portion of the vehicles’ use. As one can imagine, these types of requirements can create recordkeeping nightmares.
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