Whether you sell or trade in a business vehicle can have a big impact on your taxes. Let’s dive into the options on what to do when it’s time to sell the car you use for work.
When to sell versus when to trade in a company car
As a general rule for a business vehicle:
- Sell the car if the sale results in a loss for tax purposes (as it usually does)
- Trade in the car instead of selling it if you’d earn a profit on the sale.
Do you have to pay taxes when you sell a car?
First, you should determine whether you earn a profit or incur a loss on the sale of a business vehicle. Subtract the car’s adjusted basis from its sales price. The adjusted basis is the car’s original cost minus any depreciation deductions you’ve taken while you owned it. For example, if your car has an adjusted basis of $15,000 and you sell it for $20,000, you will earn $5,000 in profit. If you sold the car for $10,000, you’d have a $5,000 loss.
For example, if your car has an adjusted basis of $15,000 and you sell it for $20,000, you will earn $5,000 in profit. If you sold the car for $10,000, you’d have a $5,000 loss.
If you use the actual expense method to deduct your business driving, you calculate and separately deduct your depreciation deduction each year. With the standard mileage rate, you get no separate deduction for depreciation because the standard rate includes it.
To determine how much depreciation you’ve taken, multiply the total business miles you drove the car by the amount of the standard mileage rate that accounts for devaluation. These amounts appear in a chart in IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses.
Usually, a car is sold at a loss because its true resale value is less than the depreciation allowed by the IRS. A loss on the sale of a business vehicle is good tax-wise because you can deduct it from your other income. So you should sell your car instead of trading it in if the sales price is less than your adjusted basis.
Selling a business car: An example to follow
Example: Albert purchased a $50,000 car in 2009 and used it 100% for business every year. In 2014, his adjusted basis is $27,840 ($50,000 – $22,160 depreciation in deductions). The most he can sell the car for is $20,000. He should sell the car rather than trade it in because the sale will result in a $7,840 business loss that he can deduct from his income.
Selling a business vehicle: A few exceptions
The above example assumes you use the car 100% for business. If you use it less than 100%, you may only deduct the business portion of your loss.
Subject to two exceptions, you can sell your old car to anyone and deduct the business portion of your loss. You may sell to a car dealer, but you cannot purchase another car from the dealer at the same time—this would be considered a trade-in by the IRS.
- Exception #1: You cannot sell your old car to a close relative and deduct your loss. For these purposes, a close relative is any lineal descendant or ancestor, such as parents, children, siblings, or grandparents. However, this exception does not include aunts, uncles, nieces, nephews, and cousins.
- Exception #2: You cannot sell your car to a business entity, such as a corporation or LLC in which you are the majority owner, and deduct your loss. Thus, for example, you can’t form an LLC, sell your car to it at a loss, and then deduct the loss from your taxes.
A profit on a sale is bad tax-wise because you’ll have to pay tax on it. If you use your car for both business and personal driving, you must pay tax on both your business and personal profit. You’ll avoid earning a taxable profit if you trade in your car instead of selling it.
Instead of ending up with money in your pocket you have to pay tax on, the adjusted basis of your trade-in car becomes part of the tax basis of the new car. Besides, if you owe sales tax on the purchase of a new car, many states only make you pay tax on the purchase price less the value of the trade-in. Otherwise, if you sell the old car and apply the proceeds to the purchase of a new car, you would have to pay sales tax on the full purchase price.
A scenario of when to sell a business car
Example: Eva purchased a car in 2009 and used it 100% for her business every year. She paid $25,000 for the car and had taken $11,080 in depreciation by 2014. Her car’s adjusted basis is $13,920 ($25,000 – $11,080 = $13,920). A friend offers her $16,000 for the car. Should she sell it? No!
If she sells the car for $16,000, then plan for taxes on a $2,080 gain. Instead of selling it, she should trade it in for another car. This move assumes she gets a decent value on her trade-in, of course. This way she’ll have no profit she’ll have to pay tax on. Instead, her $13,920 adjusted basis in the old car will become part of the basis of the new car.
If the new car costs $30,000 and she pays $15,000 cash plus her trade-in, the new car’s basis will be $28,920. This amount is the cash she paid for the new car plus the adjusted basis of her old car.
MileIQ’s blog does not constitute professional tax advice. You should contact your own tax professional to discuss your situation.