TAXES: Sell or trade that junker?
When the day comes to replace your old business vehicle, you will need to decide whether to trade it in or sell it for cash. The most important factors to consider are money and time. More specifically, how much you receive on trade versus sale and how much time it will take to sell your vehicle.
During this process, we often overlook the tax factors that may significantly affect that decision. The following is an overview of the tax rules you can use to minimize or postpone tax when replacing your business vehicle.
Any business asset yields a gain or loss upon sale if the amount received is different from the “tax basis” of the asset, which is the remaining non-depreciated cost. Receiving more than is due yields a gain while, conversely, receiving less yields a loss. Tax-free swap rules allow the trade-in of an old business asset for a similar business asset without needing to show a loss or gain. Instead, the difference is transferred to the tax basis of the newly-acquired asset.
For example, let’s say you receive $5,000 trade-in for a vehicle used exclusively for business. Because you purchased the car for $10,000 and claimed tax depreciation of $8,000, the resulting gain is $3,000 ($5,000 value minus $2,000 tax basis).
A trade in would defer the gain until the subsequent sale of the new vehicle by reducing its basis by $3,000. The new vehicle is a sparkling new 4×4 Ford Ranger that you pay $15,000 for. The new tax basis would be calculated at $12,000 ($15,000 minus $3,000). The next day, however, your brother-in-law falls in love with your truck and wants to pay you the full original cost, requiring you first to recognize the $3,000, and then to go shopping.
Now comes the tax rule of thumb. Consider trading your vehicle if you have used it exclusively for business, as it’s almost completely depreciated and the value is higher than the tax basis. This will defer the gain and allow you to avoid current tax. However, you may want to sell the car if it has been used exclusively for business and its depreciation was limited by the “luxury auto” rules, which place a cap on the amount of annual depreciation allowed on vehicles.
Your tax basis will likely be higher than what you will receive and you could recognize the loss now. Under the swap rules, you cannot recognize the loss if you trade in your old vehicle. The loss would be shifted to the future by increasing the tax basis of the new vehicle.
Finally, you may be better off selling your old business car for cash if you used the standard mileage allowance to deduct auto-related expenses. Under the allowance (31 cents per mile after March 31) you are not able to take depreciation as an expense.
This allowance includes a factor for deemed depreciation in which 12 cents of the standard mileage allowance is considered depreciation, reducing the tax basis of the vehicle. To reach $10,000, however, you would need to travel over 83,000 business miles. Given that, the vehicle’s basis is likely going to be higher than the value received.
Be aware that the tax-free swap rules are not restricted to business vehicles and may be used on most business assets. The rules are remarkably complex and are complicated further if the assets have been used for personal, as well as business, reasons.
To assist you in sorting through this complex array of rules and to make certain that you achieve the greatest possible tax benefit, consult a tax professional before making your decision to sell or to trade.
Mark Miller is a CPA for Dennis, Gartland & Niergarth, PC, specializing in tax accounting. The firm provides a wide range of audit and accounting, tax, management consulting, small business services and computer consulting. BIZNEWS