Have a business vehicle you want to sell? Don’t make a move until you look into all the tax rules that you’ll need to follow when selling your business vehicle.
If you’re like most businesses, you’ve probably taken tax deductions over the life of your vehicle for depreciation—the wear and tear on your car as it ages. Since your business gets tax perks for depreciation, Federal tax laws are more complicated for selling a business vehicle than if you sell your family car.
Tax Cuts and Jobs Act
If you haven’t sold any business vehicles since 2017, the first thing you need to know is—federal tax laws have changed a bit since then. A new tax law—the Tax Cuts and Jobs Act (TCJA for short) took effect in 2018.
That law changed a few things you’ll need to take into consideration when you get ready to sell your business vehicle. Before the TCJA, trade-ins were usually the most cost-effective way to get rid of older vehicles, thanks to what finance pros call a Section 1031 exchange.
A 1031 exchange allows businesses and investors to exchange one property for another and put off taxes until they sell the new property for cash years down the road. Before 2018, you could apply a 1031 exchange to business vehicle sales.
But not now. Trade-ins are now taxable.
Trade-Ins Under Today’s Tax Laws
Here’s how it works in 2019. Let’s say you want to trade in your old vehicle for a new one.
You’ll need to pay income tax on the money you received for your trade minus your vehicle’s actual tax value (called the tax basis).
For example, if you paid $20,000 for the vehicle when you bought it. Let’s say it depreciated in value $4,000 per year. If you owned the vehicle for three years, its tax basis would be $8,000.
If the dealer gave you $12,000 for your trade-in, then, you would owe income tax on that $12,000 minus the vehicle’s tax basis–$8,000. That means you’d need to pay income tax on that $4,000 difference.
Business Vehicle Sales Under Today’s Tax Laws
Let’s look at how the new tax laws affect you if you sell your business vehicle outright instead of trading it in.
First, you’ll need to figure out if you owe any capital gains tax. The first thing you need to do is to calculate the cost basis for your vehicle.
The cost basis is the vehicle’s purchase price minus depreciation and any extra tax credits you might have earned. Here are two ways to calculate depreciation, both named after the sections of the tax law that govern them:
- Section 179 deduction: To qualify for this deduction, you must use your vehicle for over 50 percent of its road time for business. Only certain vehicles qualify, so you’ll need to look over the IRS rules to see whether you qualify for this deduction. If you do qualify, you can deduct most—or even all your vehicle’s purchase price during the first year you use it for business. Important other tax elections to reduce your tax.
- Section 1245 deduction: This deduction allows you to apply the IRS’ Modified Accelerated Cost Recovery System (MACRS) to your business vehicle. MACRS is a system that allows you to figure your vehicle’s depreciation over a five-year period. It also allows you to prorate your depreciation for the year you sell it, depending on the month you sell it. That means that even if you haven’t gotten a whole year’s worth of depreciation on the vehicle, you can calculate the current year’s depreciation for the months you have used it. With this method, you’ll also need to factor in the percentage of time you use the vehicle for personal trips. If, for instance, the car’s yearly depreciation is $4,000, but you used it 20% of the time for personal outings, the amount of depreciation you would claim would be $4,000 minus $800 (20% of $4,000), or $3,200.
When you sell your vehicle, you use your vehicle’s depreciated value (called “adjusted cost basis” in tax law) to find out whether your sale was a gain or a loss.
Gain or Loss?
To figure out whether your sale gave you a gain or a loss, simply subtract your vehicle’s adjusted cost basis (its depreciated value) from the amount you sold the vehicle for.
- If the answer is a negative number, it’s a loss. You can list this loss on your income tax form to offset your income.
- If the answer is a positive number, it’s a gain. You’ll need to pay taxes on that amount. But here’s where it gets a little more complicated. You have to figure out whether that gain was a capital gain (profit) or ordinary income.
Capital Gain or Ordinary Income?
If your sale produces some profit, you’ll need to pay capital gains on that profit. Here’s how you can figure out whether your sale was an actual profit or was only ordinary income:
Compare your gain the vehicle’s total depreciation amount (the depreciation for the entire time you owned it). If your gain was more than the total depreciation, you’ll need to pay capital gains tax.
Here’s where it gets a little trickier. If you’ve owned the vehicle for more than a year, you will only have to pay long-term capital gains tax. Long-term capital gains tax has a much lower rate than short- term capital gains tax. This tax difference might make it worth your while to wait until you’ve owned the vehicle for a year to sell it.
It always pays to take a look at how the tax law will affect you before you sell a business vehicle—or any other business assets, for that matter.
If you’d like to learn more about tax laws and your business, we at Akif CPA are here to help. Do you have unique issues or concerns not discussed in this blog then please contact us by email or phone. We are here to help.