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How Does Car Depreciation Work?

Foram Mehta
Your vehicle starts depreciating from the moment you drive the car out of the showroom. It's important to know how a car depreciates, when you own one. Read more..
You will need to know how a car depreciates if you are planning to buy a second hand car or even selling one. Calculating car deprecation will help you plan - when you should sell or buy a car to get a better deal.

What is Car Depreciation?

Depreciation in simple terms means a decline in the value of assets. Depreciation of a car means the decline in the value of car since it was purchased. When you buy a car, you buy it at the retail price but if you go to re-sell the same car just after buying it you will be selling it at the wholesale price. Therefore, from the moment you buy your car its worth is equal to its wholesale price.
Under normal circumstances a car depreciates between 15% to 20% per year. Depreciation rate of a new car in its first year will be higher compared to other years (considering the wholesale rate). On an average, a car depreciates to 65% approximately or more depending on its use, in a period of 5 years. Depreciation costs you about 46% of your total ownership costs in a period of 5 years.

Methods for Calculating Car Depreciation

For calculating depreciation on a fixed assets we can use the Diminishing Value Method and the Straight Line Method. However, when you are calculating depreciation for a car you can use the Standard Mileage Rate Method and Actual Expense Method.

The Standard Mileage Rate Method

In this method only a specific amount can be claimed for depreciation. Therefore, one cannot claim an additional deduction for depreciation in SMR method.
When we use the Standard Mileage Rate method, we need to multiply the number of 'business miles traveled' in a particular year with the current 'business standard mileage rate' to obtain the operating and fixed costs for your vehicle. This is a very simple method of calculating the depreciation for your car and can also be used for cars you have leased. You can deduct parking fees and toll charges that were made for business purpose. However, businessmen can also deduct interest on loans and taxes related to the car.
The Internal Revenue Service agency has announced the 'Business Standard Mileage Rate at 55.5 cents per mile, for the year 2011. But, this method cannot be used by everyone. It cannot be used by vehicles used for hire and in cases where five or more cars are operating together under the same ownership. You also cannot use the SMR method, if you have already claimed depreciation using the 'Modified Accelerated Cost Recovery System' (MACRS).
NOTE: If you want to use the SMR method to calculate depreciation then make sure that you use it in the first year, when you place your car for business. As, only then will you be able to switch to the actual expense method in the later years (Depending on which method gives you a greater deduction).

Actual Expense Method

Under this method you not only deduct depreciation but also 'business related operating expenses'. Deductible Car Expenses (besides depreciation) are as follows:-
  • Fuel
  • Interest on Car Loan
  • Garage Rent
  • Insurance
  • Oil & Gas
  • Parking Fees
  • Registration Fees
  • Repairs
  • Toll
  • Tires
  • Lease Payments
  • Cleaning
Expenses occurred for personal purposes are generally not deductible. However, interest on car loans is not deductible for employees even if you use it for work, unlike self-employed individuals.
Note: If you use the actual expense method to calculate the depreciation of your car in the first year, when you put your car for service, you might never be able to switch to the Standard Mileage Rate method.

Modified Accelerated Cost Recovery System

This method has categorized all the business assets into classes and there is a specific period in which these assets can be written off. Under this method, a car can be written off over a period of 5 years. MACRS is the only method of depreciation wherein a car owner can depreciate any car purchased after 1986.
If you have used the Standard Mileage Rate method in the first year, when you put your car for service and want to shift to the Actual Expense method a year before your car will be written off then, you will have to use the straight-line depreciation method for calculating the depreciation of the remaining life of the car.
Remember, that it is required by the law that you add your expenses only if you have relevant records or proofs for it.
For further information on forms and suitability refer to the 'Internal Revenue Service' website.

How Can Depreciation Cost Help You in Picking Your Car?

By knowing how much a vehicle will depreciate, you can get a good deal, when you plan to sell or even buy a car. Depreciation figures change, depending on the car type and model. This can help you in calculating the overall cost of a car, in the long run and thus, help you choose a more economical car.
A few cars depreciate at a rate as high as 35% per annum and in a period if 3 years the car's worth would be equal to its scrap value. Many cars depreciate between 7% to 15% per annum too, so you can actually choose a car, suitable to your pocket, by checking its depreciation rate.
Not only the depreciation cost but additional costs like cost of maintenance, repairs and insurance should be considered before buying a car.
This story will help you in understanding the concept of car depreciation and how it really works. It will also help you use 'Depreciation' for your own benefit.