Tesla (TSLA 1.50%) disclosed last week that it expects to begin losing an important customer incentive in 2018 -- and the timing could have big implications for sales of the new Model 3 sedan.

A tax break that has helped many Tesla buyers

Tesla's vehicles aren't cheap: They're sold at prices comparable to those of similarly sized models from the German luxury brands. But unlike buyers of internal combustion-powered German luxury vehicles, U.S. buyers of Teslas (and other qualifying electric vehicles) are eligible for a $7,500 tax break, courtesy of the U.S. government, which created the tax credit to encourage automakers to build electric vehicles.

A red Tesla Model S luxury sedan on a highway

A tax credit for electric-car buyers probably helped jump-start sales of Tesla's Model S when it was first launched. Image source: Tesla.

That break has made Teslas somewhat more accessible to folks who might not have otherwise even considered a vehicle that can be optioned up to well over $100,000, as Tesla's Model S and Model X can.

The tax break was intended to help jump-start electric-vehicle manufacturing, not to sustain it indefinitely. After a manufacturer sells 200,000 qualifying vehicles, the tax break begins to phase out over time, eventually going away entirely (for that manufacturer's products).

For Tesla, that moment is coming soon. In the "Risk Factors" section of its 2017 10-K annual report released last Friday, the company disclosed that it expects to achieve 200,000 sometime in 2018:

[U]nder current regulations, a $7,500 federal tax credit available in the U.S. for the purchase of qualified electric vehicles with at least 17 kWh of battery capacity, such as our vehicles, will begin to phase out over time with respect to any vehicles delivered in the second calendar quarter following the quarter in which we deliver our 200,000th qualifying vehicle in the U.S. We currently expect such 200,000th qualifying delivery to occur at some point during 2018. [emphasis added]

How the tax break will be phased out

The phaseout calendar starts once 200,000th qualifying vehicle is delivered. Buyers still get the full tax credit in that quarter and the quarter that follows. After that, the tax credit is halved (to $3,750) for two quarters and halved again (to $1,875) for the following two quarters. After that, it's gone.

Example: Suppose Tesla sells the 200,000th qualifying vehicle in July.

  • Buyers in the third and fourth quarters of 2018 will continue to get the full credit;
  • Buyers in the first half of 2019 will get a credit of $3,750;
  • Buyers in the second half of 2019 will get a credit of $1,875;
  • Buyers after that get no federal tax credit.

Again, note that the phaseout in our example only applies to vehicles made by Tesla. Each automaker gets to sell 200,000 qualifying vehicles before the tax credit begins phasing out for their buyers.

Got it? Here's why the timing of the phaseout could impact Model 3 sales and how Tesla is likely to maximize the number of buyers who get the full credit.

A blue Tesla Model 3, a compact luxury sports sedan.

Tesla will probably time its deliveries to maximize the credits available to Model 3 buyers. Image source: Tesla.

How Tesla can make the most of the remaining tax breaks

Not everyone can afford a Model S or Model X, of course. The whole point of the newest model, the compact Model 3, is that it will deliver the Tesla driving experience at a more affordable price point. It's still not exactly cheap: While a $35,000 variant has been promised, as of right now, the Model 3 starts at $44,000.

Even $35,000 is still a stretch for many people, particularly the many younger folks among the company's most ardent fans. For those people, that $7,500 tax break is enough to make the difference between buying a Tesla and settling for something else.

The impending phaseout presents a challenge for Tesla: How can it get the full tax break for the largest number of customers, particularly Model 3 customers?

Tesla is currently working to ramp up production of the Model 3. It expects to be up at full speed -- 5,000 cars a week -- by the end of the second quarter. Given that, I expect that Tesla will do everything it can to avoid hitting the 200,000-vehicle milestone until the beginning of the third quarter in order to maximize the number of tax credits available to its Model 3 buyers.