Hybrid Cars - Better to Buy Now or Later?

WHY BUY IN 2005? As previously discussed, for buyers situated in states that charge sales tax, the ability to deduct sales taxes for federal income tax purposes is due to expire on December 31, 2005. Therefore, unless this deductibility is extended, it is advantageous for those persons to purchase large ticket items in 2005.

If the vehicle is a qualified hybrid vehicle, a deduction of up to $2,000 of the cost is also allowed if the vehicle is purchased in 2005. This is a useful deduction since it is "above the line" - it is deductible even if you do not itemize deductions, and is not subject to the phase-out of itemized deductions that applies to higher income taxpayers.

WHY BUY IN 2006? In 2006, a qualified hybrid will qualify for a tax credit from $400 to $3,400, depending on the model. A tax credit (the 2006 and beyond incentive) is better than a tax deduction (the 2005 incentive) of the same amount, since it reduces taxes dollar-for-dollar. A tax deduction only reduces the amount of income subject to tax, and thus does not reduce the tax bill dollar-for-dollar.

SO WHICH YEAR TO BUY IN? A comparison needs to be made in regard to whether a tax deduction of up to $2,000 is better in 2005, or a tax credit for the particular model car for a 2006 purchase of hybrid. Other factors favoring a 2005 purchase are the more immediate tax benefit on a 2005 tax return (instead of a 2006 return), and the above sales tax deduction for 2005 if applicable. One last factor to consider is that the tax credit will only fully apply to 60,000 vehicles from each manufacturer - thereafter, the credit is reduced and eventually eliminated for such manufacturer. A 2006 purchase runs the risk that your desired hybrid model may not qualify for the full credit due to this limit.