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The deduction is limited to the state and local sales and excise taxes paid on up to $49,500 of the purchase price of a qualified new foreign or domestic cars, SUV's, light trucks, motor homes or motorcycles that weigh no more than 8,500 pounds. You can still buy a qualifying vehicle for more than $49,500 (e.g a $80,000 BMW per a commenter's question below), but you will only get a tax deduction up to the specified limit.

The deduction is only available to families making less than $260,000 (or $135,000 for single filers). It is phased out for taxpayers whose modified adjusted gross income is between $125,000 and $135,000 for individual filers and between $250,000 and $260,000 for joint filers.

The new vehicle must be purchased on or after Feb. 17, 2009, and before Jan. 1, 2010, to qualify for the deduction. Purchases before Feb. 17, 2009, are not eligible for this special deduction.

How to claim the tax deduction : The deduction is available regardless of whether a taxpayer itemizes deductions on their return (Schedule A). The deduction cannot be taken on 2008 tax returns (even if they are amended or filed late), so must be claimed when they file their 2009 returns in 2010. Also, unlike other tax credits in the economic stimulus package this tax break is not an offset to your federal taxes (i.e. a tax credit), it is a deduction against your taxable income. Taxpayers who take the standard deduction need to complete Schedule L and attach it to tax forms 1040 or Form 1040A to increase the standard deduction by the allowable amount of state or local sales or excise taxes paid on the purchase of the new vehicle. Also, check the box on line 40b on Form 1040 or line 24b on Form 1040A. Individuals who itemize should include the allowable amount of state or local sales or excise taxes from the purchase of the vehicle on Form 1040, Schedule A.

To illustrate the above tax deduction, consider the following example from a commenter. The average new car purchase price the first 11 months of last year was $28,280, and the average used car trade-in value was $15,203, according to data from the National Automobile Dealers Association.

States typically tax the difference — $13,077 in this case. So a 5% sales tax rate would be $654, meaning the deduction would reduce taxable income that much. Each state has a different car sales tax, so the deduction will vary by state.

States without new car sales tax: The IRS and treasury have recently determined that purchases made in states without a sales tax – such as Alaska, Delaware, Hawaii, Montana, New Hampshire and Oregon – can also qualify for the new car tax deduction. The IRS stated taxpayers who purchase a new motor vehicle in states that do not have state sales taxes are entitled to deduct other fees or taxes imposed by the state or local government. The fees or taxes that qualify must be assessed on the purchase of the vehicle and must be based on the vehicle’s sales price or as a per unit fee.

“This special tax break is available for people purchasing a new car this year, and that can include people in states without a sales tax,” said IRS Commissioner Doug Shulman. “This means that more people can take advantage of this deduction when they file their tax returns next year.” To qualify for this deduction, the vehicle must be purchased after Feb. 16, 2009, and before Jan. 1, 2010. Taxpayers can claim this special deduction only on their 2009 tax returns to be filed next year.

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