Questions on vehicle purchases and sales might be the most often asked business tax question we receive at our firm. Factors such as cash flow, sale proceeds versus trade-in credit and the time it takes to sell a vehicle outright are all important factors in the decisions to buy or sell a vehicle.
In this article, I’m going to discuss the tax ramifications of selling your car versus trading in your car and how simple details can result in huge tax savings.
In general, the sale of a vehicle will generate a gain or loss depending on the net proceeds you receive from the sale and your basis in the vehicle. “Basis” is your cost for tax purposes and, if you bought the vehicle, usually is calculated using the following formula:
Purchase price + expenses of sale (like sales tax) – depreciation deductions claimed = Basis
Under the VERY favorable like-kind exchange rules, trading in an old vehicle for a new, like-kind vehicle doesn’t result in a current gain or loss, and the new vehicle’s basis will equal the old vehicle’s remaining basis plus any cash you paid to trade up.
Here are a few general rules of thumb to help you make the best tax decision on your vehicle sale.
As a general rule, you should trade in your old business car if you used it exclusively for business driving, and its basis has been depreciated down to zero, or is very low.
The trade-in often avoids a current tax. The reason this is often the most used tax savings technique is because tax depreciation is front loaded with deductions so you receive a higher deduction, sooner. If you sell your business car for $11,000, and your basis in it is only $9,000, you will have a $2,000 taxable gain, but if you trade it in, a current tax is avoided. The $2,000 gain is subtracted from the basis in your new car and now your basis in the new car will be lower than it would be if you bought it without a trade-in, but that doesn’t necessarily mean lower depreciation deductions on the new car. Because of the so-called “luxury auto” annual depreciation dollar caps, your annual depreciation deduction on the new car may be the same whether you sold the old car or traded it in.
Consider selling your old business car for cash rather than trading it in if you used it exclusively for business driving and depreciation on the old car was limited by the annual depreciation dollar caps.
You can learn more about the annual depreciation dollar caps here.
In this situation, your basis in the old car may exceed its value. If you sell the old car, you will recognize a loss for tax purposes. However, if you trade it in, you will not recognize the loss.
Let’s use a simplified example. Everyone who knows me knows I LOVE cars.
Let’s assume I bought a $30,000 car several years back and used it 100% for business driving. Because of the annual depreciation dollar caps, I still have a $16,000 basis in the car, which has a current value of $14,500. Now, I want to buy another $30,000 car. If the old car is sold, a $1,500 loss will be recognized ($16,000 basis less $14,500 sale price). If the old car is traded in for a new one, there will be no current loss. Of course, if the old car’s value exceeds its basis, the tax-smart move is to trade it in and thereby avoid a gain.
You also may be better off selling your old business car for cash rather than trading it in, if you used the standard mileage allowance to deduct car-related expenses.
The standard mileage allowance has a built-in allowance for depreciation, which must be reflected in the basis of the car. For 2017, the allowance is 53.5¢ per business mile driven. The deemed depreciation is 25¢ for every business mile traveled during 2017. When it’s time to dispose of a car, the depreciation allowance may leave you with a higher remaining basis than the car’s value. Under these circumstances, the car should be sold in order to recognize the loss.
If you use your car partially for business, partially for personal use, the rules are more complicated:
- If you sell the part-business, part-personal-use car, cost and depreciation must be allocated between the business and personal portions. Gain or loss on the business part is recognized; gain, but not loss, is recognized on the personal part.
- If you trade in the part-business, part-personal-use car, a special basis rule applies for depreciation purposes only: The basis of the new car as computed under the normal trade-in rules is reduced by any difference between (1) the depreciation that would have been allowable had the old car been used 100% for business driving, and (2) the depreciation claimed for its actual business use.
Making the decision to sell or trade-in your business vehicle is complicated. We haven’t even got into situations such as selling to a relative, or selling your personal car to the business. Before you make the decision, give us a call and we can go over the facts to get the most tax savings for you. Then, you can enjoy your new car knowing you made the best decision!