This 2024 rule change could crush Tesla shares

Tesla is losing a valuable tax credit on some vehicles. Here's what it means.

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Blue Model Y Tesla vehicle

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This article was originally published on All figures quoted in US dollars unless otherwise stated.

Tesla's (NASDAQ: TSLA) pricing power may be becoming a thing of the past.

The electric vehicle (EV) leader has slashed prices on its vehicles several times this year in a bid to remain the top dog in the space and to drive sales. In its third quarter, Tesla's average selling price across its vehicles fell by roughly $9,000 to just over $45,000.

CEO Elon Musk spent much of the third-quarter earnings call arguing about how important it is for Tesla to be competitive on price. Musk explained that most car buyers use some form of financing so the company has lowered prices on its vehicles to counter higher interest rates and keep monthly payments from going up.

Musk also said "there's very significant price elasticity" in the auto sector and with Tesla, which might surprise some investors, who would assume that Tesla is able to charge higher prices because it's perceived to have better technology or a better brand.

However, in its struggle to reach pricing parity with mainstream vehicles, Tesla could run into another obstacle in 2024.

Tesla's tax credit incentives are shrinking

Musk acknowledged the $7,500 EV tax credit on the call as well, but said it wasn't as much of an incentive as it might seem because it's a burden for some Tesla buyers to wait until tax season to collect the credit.

However, Tesla is now warning customers on its website that some of its vehicles will no longer qualify for the full $7,500 credit. According to Tesla, the Model 3 rear-wheel drive (RWD) and the Model 3 long-range options will only qualify for $3,750 in tax credits, rather than the full $7,500 credit, because some of their components come from China.

The Department of Energy modified the tax credit at the beginning of December, and the two Tesla Model 3 trim levels that will be impacted by the move are Tesla's cheapest, meaning they could dissuade some of Tesla's most price-sensitive customers.

Tesla is using the rule change to try to incentivize purchasing these vehicles before the end of 2023, but that announcement also seems like an acknowledgment that the lower incentive could be a challenge to selling those cars.

Will the change hurt Tesla?

The change in the tax incentive will only affect a minority of Tesla buyers as most of its car sales come from outside the U.S. Moreover, the Model Y outsells the Model 3, though the Model 3 is its second-best-selling vehicle.

The tax incentive change also only applies to two of the three trim levels it offers on the Model 3. The most expensive Model 3 performance trim is not affected. It's unclear what percentage of the Model 3 sales come from the affected trim levels, but one can assume that about 10% of Tesla sales come from the Model 3 RWD and long-range trims sold in the U.S, since about 40% of Tesla's sales come from the U.S. and the Model 3 is its second-most-popular model in the U.S.

Taking Musk's comments at face value, it would seem that a significant percentage of the affected Model 3s may become too expensive for Tesla's customers. Before the credit, the Model 3 RWD starts at $38,990 with the long-range version at $45,990. Adding nearly $4,000 to the cost of the vehicle is likely to spook some customers away.

While losing a few percentage points of revenue might not seem like a big deal, Tesla stock is priced for perfection, and the business is currently struggling with slowing revenue growth and falling profits, as well as signs that the broader EV market is weakening.

In other words, the tax credit change is poorly timed for Tesla, and it's likely to contribute to its challenges. Considering its pricey valuation and broader macroeconomic pressure, that could lead to a sharp sell-off in Tesla stock next year. 

This article was originally published on All figures quoted in US dollars unless otherwise stated.

Jeremy Bowman has no position in any of the stocks mentioned. Motley Fool contributor Jeremy Bowman has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Tesla. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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