Mileage Reimbursements Can Create a Hidden Tax Loss | Fullerton

If you receive mileage reimbursements from your employer or your corporation, you may face an unexpected tax result when you sell or trade your vehicle.

Many employees assume that mileage reimbursements end the tax story. That assumption often leads taxpayers to miss a valuable deduction—or to get blindsided by a taxable gain.

When your employer reimburses you at the IRS standard mileage rate under an accountable plan, the tax law treats your personal vehicle as a business vehicle. The standard mileage rate includes a built-in depreciation component. Each reimbursed mile reduces your vehicle’s tax basis, even though you never claim depreciation on your return and never include the reimbursements in income.

This basis reduction matters when you dispose of the vehicle.

Consider Leo, a W-2 employee who bought an $85,000 car and used it 100 percent for business. Over four years, his employer reimbursed him $33,304 for business miles. Those reimbursements felt like full payback. But embedded in those payments was $14,815 of deemed depreciation, which reduced Leo’s basis in the vehicle to $70,185.

When Leo traded the car for $47,000, the tax law treated that trade as a taxable disposition. Because vehicle trade-ins no longer qualify for like-kind exchange treatment, Section 1001 required Leo to compare his trade-in value to his adjusted basis. The result surprised him—in a good way. Leo realized a $23,185 loss.

Because the vehicle qualified as depreciable business property held for more than one year, Section 1231 turned that loss into an ordinary deduction. Leo reported the transaction on Form 4797 and deducted the loss against ordinary income, even though his employer reimbursed every business mile he drove.

This result often surprises employees and corporate owner-employees. Mileage reimbursements cover current operating costs and a portion of wear and tear, but they do not recover your full investment in the vehicle. When you sell or trade a mileage-reimbursed car for less than its remaining basis, the tax code allows you to deduct the unrecovered amount.