Some Brief Thoughts on the New Car Tax Break

Just a quick comment on one aspect of Obama’s just-announced plan to “see the auto industry through these difficult times.” I’ll keep this brief since it has little to do with either real estate or the Seattle area.

Here’s a portion of the president’s speech:

…the IRS is today launching a campaign to alert consumers of a new tax benefit for auto purchases made between February 16th and the end of this year – if you buy a car anytime this year, you may be able to deduct the cost of any sales and excise taxes. This provision could save families hundreds of dollars and lead to as many as 100,000 new car sales.

[Clarification: Obama is referring to the tax break for any new car purchase (not just American-made cars) that was passed as a part of February’s “stimulus” bill.]

Let’s just say that hypothetically I’m in the market for a car. For the purposes of this example, we’ll choose a fuel-efficient, American made branded car: the Chevrolet Aveo.

I have two choices:

  1. Buy a new 2009 Aveo, priced at local dealers between $11,000 and $17,000. I get to deduct up to about $1,700 in taxes from my taxable income, and save approximately $425 on my 2009 taxes (at the most).
  2. Buy a used 2007 or 2008 Aveo, priced at local dealers between $9,000 and $10,000. Save $1,000 to $8,000 compared to buying new.

Tough choice, isn’t it? Maybe someone can explain to me how this program is supposed to convince even one person that now is a great time to buy a new car.

  

About The Tim

Tim Ellis is the founder of Seattle Bubble. His background in engineering and computer / internet technology, a fondness of data-based analysis of problems, and an addiction to spreadsheets all influence his perspective on the Seattle-area real estate market.

36 comments:

  1. 1
    Lionel says:

    Interesting snippet from zerohedge. Deutsche Bank anticipates 24% decline in Seattle prices from 4Q 2008.

    http://zerohedge.blogspot.com/2009/03/47-more-price-declines-for-ny-real.html

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  2. 2
    deejayoh says:

    Because people aren’t very smart :^)

    Used cars pretty much always make more sense from a financial standpoint, but people are seduced by that “new car smell”. That, plus the promise of zero percent financing.

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  3. 3
    The Tim says:

    Also, is it any wonder that new car sales are in the toilet when so many sales were financed by cash-out re-fis during the boom? I mean seriously, how often do you really need a new car?

    I drove my (almost) first car from 1997 until I totaled it in 2006, at which point I paid cash for a nice used ’01 Saturn. I realize I’m in the minority here, but when money’s tight, the decision between spending thousands on a new car or a few hundred to keep up the old one is essentially made for people by their checkbook.

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  4. 4
    Patrick says:

    Your car example seems kind of skewed to the least favorable conditions, not realistic, unless I’m not understanding this, which is possible.

    Quickly running to Edmunds.com. At this point you can basically buy a new aveo at cost. So let’s take the base level, no frills. Cost about $12,000. There’s a $1000 rebate plus another $1000 to help move cars sitting on the lot. So that’s $10,000. Then, roughly $1100 deducted from your taxes. $8900, right. Then the last part, which honestly, I’m not sure how is calculated, but what’s written is $425, so that is $8475 for the cheapest, but brand new Aveo.

    Disclaimer: I didn’t check really hard for accuracy…and why would you ever get an aveo over an accent???

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  5. 5
    sf_boomerang says:

    You can’t put a price on that New Car Smell, Tim.

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  6. 6

    1. Buying new cars is really stupid, but guess it’s a good thing for the economy? I’ve never owned a new car.

    2. The Chevy Aveo is Korean made. It’s a Daewoo( a GM subsidiary) with a Chevy nameplate.

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  7. 7
    The Tim says:

    By Patrick @ 4:

    Then, roughly $1100 deducted from your taxes. $8900, right.

    Whoa, wait, stop right there. You’re taking $1,100 and treating it as a direct credit to your tax bill. Where does that come from? Is there some sort of new car tax credit already in place that I’m not aware of?

    There is an important and major distinction between a tax credit and a tax deduction. This program is the latter.

    If you pay $10,000 for a new car, you’re going to pay approximately $1,000 in taxes, correct? This program allows you to deduct that amount from your taxable income, which means that the IRS will treat it as though you earned $1,000 less in 2009 than you really did.

    So if you’re in the 25% tax bracket (the number I used for the rough example in the post), that’s a savings on your 2009 tax bill of 25% of $1,000, or $250.

    Then the last part, which honestly, I’m not sure how is calculated, but what’s written is $425, so that is $8475 for the cheapest, but brand new Aveo.

    $425 was the maximum tax break you would get in my example, if you bought the $17,000 car, paying $1,700 in taxes. 25% of $1,700 = $425.

    …and why would you ever get an aveo over an accent???

    Yes well that’s a whole different reason why this plan seems as though it will have little to no effect on “saving” the Detroit automakers.

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  8. 8
    The Tim says:

    RE: Ira sacharoff @ 6 – Doh, thanks for the correction, Ira. Post corrected.

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  9. 9
    Kary L. Krismer says:

    I think it’s Germany that has a $7000 tax credit if you trade in an older vehicle, which is then destroyed. Even that wouldn’t get me to act even though today my truck is 20 years old. So I agree this lesser plan won’t do much.

    While as I mentioned recently I don’t think much of buying cars, I disagree with Tim on the new vs. old debate. I like new because I like to know how the vehicle was maintained. My 20 year old truck can still go 5,000 miles without adding a quart of oil. While it’s possible I could have picked up a used vehicle for 25% less, at this point that difference would only be about $20 a month, assuming I didn’t have to pay for an engine rebuild if I’d bought used.

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  10. 10
    Tsuru says:

    I’m just about to make the last payment on my car this month, and I plan on driving this car for at least another 8-10 years. If you maintain your car properly by changing the oil regularly and having the routine maintenance performed near the appropriate interval, there is no reason it shouldn’t last a good long time.

    It seems that the culture of consumption in the U.S. has convinced everyone that they NEED a new car every 3 years. If your car has more than 50,000 miles on it, it’s a pile of junk that is in danger of collapsing in a heap on the freeway. BUY A NEW ONE NOW. I used to get a letter from Subuaru every three months or so promising me a guaranteed trade-in value if I bought a new Subaru.

    But I guess I’m not being a good citizen here. How can we expect the economy to get better unless we all assume massive piles of government-backed debt?

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  11. 11
    Patrick says:

    Oh, shot. Read that wrong; thought it was a tax credit. Off hand, if you get $2000 dollars off rebate from chevy, you have to still pay taxes on that. That’s were I got $1100 from the $10,000.

    Thanks for the clarification The Tim.

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  12. 12
    Scotsman says:

    It’s the perfect government program- I doubt it will help to sell a significant number of new cars that wouldn’t have been bought anyway. But it will reduce federal tax revenues because of those cars that are going to be purchased without regard to tax policy. It’s a perfect example of inept government meddling.

    In my opinion the only reason to buy new is if you plan to keep the car forever and want to ensure all the initial service and maintenance is done properly. Nothing prolongs a car’s life like proper and complete care, esecially the first services. Otherwise, the premium for the new car smell is too much.

    I’ve never bought new, and have had a loan only once, on a used car I bought in college. Since then it’s always been used, paid for with cash, Audi’s for the cars, Chevy for the trucks/suburbans.

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  13. 13
    Kary L. Krismer says:

    By Scotsman @ 12:

    It’s the perfect government program- I doubt it will help to sell a significant number of new cars that wouldn’t have been bought anyway. But it will reduce federal tax revenues because of those cars that are going to be purchased without regard to tax policy. It’s a perfect example of inept government meddling.s.

    The $7,500 tax credit for a first time home buyer was probably worse in that regard. I’d guess that over 50% of the sales were done without the buyer knowing about it at the time they started looking. The $8,000 one is only slightly better known.

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  14. 14
    masaba says:

    The thing that gets me is that you are actually able to find a 2007-2008 used Aveo in 2009. I bought my car new in 2002, and plan on owning it for at least 5-10 more years. It’s silly to buy a new car every 2-3 years.

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  15. 15
    Groundhogday says:

    By Lionel @ 1:

    Interesting snippet from zerohedge. Deutsche Bank anticipates 24% decline in Seattle prices from 4Q 2008.

    http://zerohedge.blogspot.com/2009/03/47-more-price-declines-for-ny-real.html

    That sounds about right if there aren’t major layoffs. If there are major layoffs (Boeing? State government? University of Washington?) prices could overshoot on the downside by significant amount.

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  16. 16
    rose-colored-coolaid says:

    What you’re missing, Tim, is that American’s react completely irrationally to tax breaks. It should be entirely unexplainable why people would eagerly pay interest to banks just to save 25% of that interest in tax breaks. I think what it comes down to, is that American’s (enough of them anyways) are so unhappy with paying income tax that they actually value tax savings at a much much higher rate than the monetary value.

    Saving 4% on your car is not a big deal unless you actually value that $400 in savings at 5x it’s actual value (5x estimate is based on the fact that many deductions, like housing interest are treated as “great deals because of tax savings”). Using the stupid-American-who-doesn’t-understand-math-but-hate-taxes equation, you get a perceived savings of $2000 on $400 in real savings. Suddenly, the new car is looking like a better “deal”.

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  17. 17

    TIM, YOU’RE THE PERFECT ENVIRONMENTALIST

    What better way to recycle thousands of pounds of horrifying material than to buy a used car? Mayor Nickels should be pushing used cars, not cotton grocery bags….by the way, cotton is one of the most environmentally unfriendly crops on earth, next to tobbaco. The cotton bags rot holes fast when they get wet too, then all your groceries splat on the ground unexpectedly….LOL.

    Obama just announced today on just GM and Chrysler auto warrantees:

    Ford, Toyota, Kia, etc., should be horrified; he’s backing GM and Chrysler warrantees with federal money….that means these domestic managed/engineered [the American college jobs gang] cars have the best warrantees if/when all the world’s car companies collapse soon.

    I see the Asian and European stocks totally crashed too on news that Obama rejected GM/Chrysler restructuring plans….but the rest of the world is immune from America’s industrial base and college engineering base demise, LOL.

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  18. 18
    Acerun says:

    Have you ever smelled a new car?

    As far as new vs. used, we are lucky we live in an area where there is not salt on the roads for 6 months a year. In the Midwest and Northeast cars (exterior and below) are slowly eaten by salt, thus not lasting 20 plus years.

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  19. 19
    Mike2 says:

    Congrats for picking the only rental car I’ve ever had to return early because it was just too awful to drive. After 3 days there was no way I could deal with the Aveo for another 2 weeks.

    Regarding the tax deduction, wasn’t there a similar sales tax deduction in 2006?

    Acerun, no kidding. It’s rare to see cars over 15 years old in the areas that use de icer. The corrosion starts quick. After just 2 east coast winters the exposed bolts under my car are already getting more difficult to remove.

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  20. 20
    AmyM CPA says:

    It depends upon how they structure this, but if it’s just a matter of tagging on a deduction to the Schedule A (Itemized deductions) we already have that benefit here in WA, so there’s really no incentive.

    WA residents get to deduct sales tax anyway if they itemize deductions. You normally have to choose between state tax OR sales tax. So, if you live here in WA, there is no additional benefit for those who itemize their tax deductions, i.e. anyone who owns property.

    In fact, when I moved here in 2007, we moved from a state with income tax and I purposely waited to buy the car until 2008, knowing I could deduct the sales tax. We looked for the model I wanted in used cars but there were none or they were priced maybe $2,000 below new. So I knew I was just trading miles for dollars and since I keep my cars for so long it made sense for me. But then again I could afford to pay cash and I was going to buy a new car anyway. The tax incentive just changed my timing.

    A year later I still love my Toyota that will probably last me another 10-12 years.

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  21. 21
    singliac says:

    What a timely piece. I actually did this math over the weekend, because I was looking for a minivan (I know, mini-van for a mini-man, ha ha). Anyway, I was tempted by Kia’s $5000 rebate, 0% financing, and what I thought was a sales tax credit. It turned out that you either choose $5000 rebate or 0% financing. Also I realized that the tax break was a deduction, and it would only save me a few hundred. I decided to go back to my original plan of buying a used vehicle. I’m really glad I did. I found a 2008 Sedona with < 20,000 miles for 14.5k (16k after taxes).

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  22. 22
    singliac says:

    RE: AmyM CPA @ 20

    True, but I’d guess that since a lot of us on this site are renters, the standard deduction is still greater than itemizing. Regardless of our individual situations, the tax incentive – as you and The Tim point out – isn’t much of an incentive.

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  23. 23
    AmyM CPA says:

    O.k. I just read part of the plan. This will be a credit, NOT a deduction, which means you don’t have to itemize your deductions to qualify and depending on the calculation, may be dollar for dollar.

    There is an income limit to qualify . So, many of the people that have the money to buy a new car may be locked out or phased out.

    The amount of the new purchase is limited.

    You won’t get the credit until you file your taxes several months later.

    In an odd twist, motorhomes and motorcycles qualify.

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  24. 24
    The Tim says:

    RE: AmyM CPA @ 23 – Can you point out where you read that this is a tax credit? Everything I’ve read regarding the actual final plan passed by Congress in the “stimulus” says it is a deduction—including the portion of Obama’s speech today that I quoted in the post.

    Here’s an example of what I’ve read, this is from a New York Times story, post-final-passage of the bill:

    CAR BUYER TAX DEDUCTION For the rest of 2009, you’ll be able to deduct the state and local sales and excise taxes you pay on the purchase of a new (not used) car, light truck, recreational vehicle or motorcycle.

    This will be an “above-the-line deduction,” according to Clint Stretch, the managing principal of tax policy at Deloitte L.L.C. in Washington. That means that you can take it regardless of whether you itemize other deductions on your tax return.

    Also this from the Wall Street Journal:

    Consumers who had hoped for a big tax break for buying a new car also will be disappointed. An $11.5 billion break proposed by the Senate is now down to just $2 billion, with tighter limits on who qualifies. Among other things, the proposal would allow buyers a federal income-tax deduction on local taxes on new-car purchases.

    More links that say it’s a deduction, not a credit:
    http://www.huffingtonpost.com/huff-wires/20090213/stimulus-auto-sales/
    http://www.bankrate.com/dls/news/auto/20090224_auto_stimulus_a1.asp
    http://www.usatoday.com/money/economy/2009-02-12-stimulus-package-effects_N.htm

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  25. 25
    singliac says:

    RE: AmyM CPA @ 23
    Yeah, where did you get that info? You are right that it can be deducted regardless of whether you are itemizing or not, but everything I’ve read said it was a deduction, not a credit.

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  26. 26
    Scotsman says:

    RE: AmyM CPA @ 20

    It’s a federal program, not state. I’m confused by your analysis.

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  27. 27
    singliac says:

    RE: Scotsman @ 26 – Amy didn’t say that this federal program will be applied differently in WA. She is just pointing out that since WA doesn’t have an income tax, most people who itemize won’t have any incentive at all to use this tax break (they already get it by deducting sales tax). But I think she was mistaken about it being a credit. In that case, it’s probably a good thing she didn’t provide a link to her CPA business.

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  28. 28
    DaveyDave says:

    As far as different approaches for car ownership and the financial ramifications, here are 3 comparisons. In each, I’m assuming inflation is 0%, a 5% annual rate of return, and 30 year time duration. Mind you, this is a rough comparison and can certainly be fine tuned. It ignores insurance, maintenance, gas, value of the new smell of vinyl, etc. — it just shows an order of magnitude.

    Scenario #1: A person continuously pays a car loan every month for 30 years. This would be true for leasing or getting a new car every few years. With a car payment of $400, this person is out a present value of $74,500 at the end of 30 years.

    Scenario #2: A person buys a new car every 10 years totalling 3 cars all told. Each car is financed for 5 years with a $400 monthly payment, paid off, and then held for an additional 5 years free and clear. This person pays a present value of $21,200 for each vehicle. There is then a period of 5 years for each car when the $400 monthly outlay can go into savings once the car is paid off. This would equal a present value of plus $21,200. This person winds up with 3 cars over a 30 year period and has a $0 present value with a $400 monthly outlay.

    Scenario #3: A person does not have a car, but saves $400 per month yielding a present value of plus $74,500 in the savings account.

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  29. 29
    Nick says:

    What’s funny is that the analysis isn’t even factoring in the cost of simply maintaining an existing car, as opposed to getting a new one (new or used) in the first place. As Tsuru said, it’s not like it’s not viable to keep a car for 10 years or more: they don’t suddenly explode in the middle of the road after some fixed period of time, contrary to the manufacturer’s optimal design goals and subtle marketing spin. Regular maintenance should be much less than either option, and I can’t see many people rushing to waste extra money these days.

    As a side note, I’m a statistic in this case. I bought my car, new, a little over five years ago, and just paid it off. I was intending to hold it for another year or so and then look for another [new] car, but a combination of lack of compelling new features, some regressions (no way to use nav while moving on current models I’m interested in, unlike my current car), and the uncertain private business environment (due to complete lack of government support, constantly changing laws and regulations, and impending nationalization of industries) has left me feeling like it would be much better to just hold onto it indefinitely. I have no idea how much private industry will be left in the country after a few years of Obama, and/or if I’m going to need to have a government job to be employed, and if so how much they’ll dictate that I am paid. Given that, it seems like a bad time to be making any long-term financial commitments, especially on superfluous luxuries; it’s just the nature of the environment of fear and uncertainly the government has created, especially for people with savings and/or income.

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  30. 30
    Joel says:

    By deejayoh @ 2:

    Because people aren’t very smart :^)

    I think Ditech would beg to differ.

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  31. 31
    Scotsman says:

    RE: Joel @ 30

    How’s that theory working out?

    http://finance.yahoo.com/echarts?s=DITC#symbol=DITC;range=2y

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  32. 32
    patient says:

    I like cars and I only buy new cars. It’s not the best financial option but we only buy with cash savings and for us a couple of thousands “lost” by luxuary consumption will not make or break important areas as college funds or retirement. New cars have imo better passive and active safety and provides some peace of mind that you will not be stranded on a deserted road at night with your babies in the back. And no I’m not in the car industry and I fully realize the better value of used cars and understand the people who buy them, I just prefer new.

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  33. 33
    wreckingbull says:

    I don’t buy new since new cars contain EDRs. If I am in an accident the last thing I need is my insurance company refusing to pay since they did not like my driving inputs at 0.5 seconds prior to the collision event. As far as I am concerned, the ‘sweet spot’ for cars is the 1998-2002 model range. This is when fuel injection and engine management systems really worked out all the issues, but before cars became computers on wheels that they are today.

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  34. 34
    patient says:

    The inventory of homes for sale is strangely conistent. It feels like it’s moving in a very narrow range between 9900 and 10100. More or less nothing is selling and nothing is listed?

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  35. 35
    Joel says:

    RE: Scotsman @ 31
    At least they’re not Cleveland.

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  36. 36
    Amber says:

    That sucks…I bought my car january 31st, which is literally two weeks before the start of the program. Why not make this for the entire year of 2009?

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