Cars are one of the most expensive items to own, both in terms of the initial investment we make in them and in the cost of ongoing maintenance. Fortunately, there are valid ways to offset these expenses with tax deductions. You might qualify for one or more of these options for personal, small business, self-employed or business deductions.

(If you're not taking advantage of these deductions, you could be missing out on tax savings. Check out 5 Tax Credits You Shouldn't Miss.)

Key Takeaways

  • If you own a business or work for yourself, you may recognize that owning and operating a car for work purposes can become a large expense.
  • The IRS allows certain car expenses used for qualified business purposes to be written off on one's tax returns.
  • There are several deductions and ways to include car costs as a business expense, including donating an old car to charity, logging business miles traveled, and adding vehicles to a company fleet, among others.

1. Charitable Contributions

If your old car isn't going to make it much longer, and the cost of repair isn't worth the investment, consider donating it to charity rather than trying to make a little money selling it used. You'll save the hassle of putting up an ad and dealing with potential buyers who want to talk you down from your price. And if you know your car isn't worth a whole lot, you may be better off donating it, which will give you a deduction for the market value the car still has. Many charitable organizations will even pick up your donated car for you. This method of tax deduction can apply to personal or business application, just make sure you get an official receipt from the charity, which should include the value of the vehicle you donated.

2. Hybrid Cars

If you purchased a hybrid car on or before January 1, 2011, you can get a tax credit which directly deducts an amount from your federal tax owed, dollar for dollar. Unfortunately, the credit program phased out, so hybrid car purchases after January 1, 2011 cannot be claimed on your taxes. Businesses might be eligible for this tax deduction too, if you've purchased a new hybrid car or restocked your business fleet with hybrid vehicles prior to the deadline. While hybrid vehicles can be fairly expensive, the offset from a tax deduction, plus the money you'll save in fuel, can make this a smart investment.

3. Convert Your Car

Keeping your current car but wanting to reduce emissions? Look into a electric drive conversion kit, which you can hire a professional mechanic to install onto your car. Before you purchase the kit, get a mechanic's opinion on whether your car is worth converting; in some cases, such as on older cars that don't have much life left in them, the cost of conversion may be an investment not worth making. But if you have a newer car with a lot of life left in it, converting can save you on fuel daily as well as giving you a nice tax credit, up to $4,000. The tax credit for conversions phases out on December 31, 2011, so convert your car this year.

4. Deduct Business Use

If you are a freelancer and otherwise self-employed individual, you can deduct the cost of business use, even if it's on your personal vehicle. This is the best method for those who work under a sole proprietorship rather than as a legal business structure such as a corporation. The key here is to separate business use from personal use.

5. Small Business Fleet Deductions

If you're running a small business, a vehicle used exclusively for business can add to your yearly tax deductions as part of your operating expenses. While the cost of overhauling a business vehicle doesn't qualify as a deduction (overhauling must be included in capitalization cost and calculated in the depreciation cost), the cost of repair can be deducted. Keep clear records of repairs, because just claiming an estimated cost won't go over well with the IRS.

6. Unreimbursed Business Expenses

If you're employed by a company and have used your own personal vehicle for business-related purposes, you can claim those expenses on your tax deduction if your company has not reimbursed you. These expenses could include fuel costs and maintenance, and are usually best calculated by using a per-mile cost, which the IRS updates on a regular basis. As with self-employed tax deductions, the key is to keep clear records and differentiate between business use and personal use.

The Bottom Line

Unless you're using your car exclusively for your business, you can't deduct the full cost of purchasing, maintaining and repairing it. You can and should, however, deduct what you can. The key, as with almost any issue to do with the IRS, is having clear records to support your claims.

(Besides creating ongoing income and capital appreciation, real estate provides deductions that can reduce the income tax on your profits. See Tax Deductions For Rental Property Owners.)