The decision of whether to trade in an old business car or try to sell it for cash generally should be based on factors such as the amount you can get on a sale versus a trade-in, and the time and bother a sale will entail. However, important tax factors also may affect your decision-making process. Here’s an overview of the complex rules that apply to what appears to be a simple transaction, and some pointers on how to achieve the best tax results.
In general, the sale of a business auto yields a gain or loss depending on the net amount you receive from the sale and your basis for it. Your “basis” is your cost for tax purposes and, if you bought the asset, usually equals your cost minus the depreciation deductions you claimed for the auto over the years. Under the tax-free swap rules, trading in an old business auto for a new one doesn’t result in a current gain or loss, and the new car’s basis will equal the old car’s remaining basis plus any cash you paid to trade up. 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. For example, if you sell your business car for $9,000, and your basis in it is only $7,000, you will have a $2,000 taxable gain, but if you trade it in, a current tax is avoided because any gain is deferred. 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 deductions on a new car may be the same whether you sold the old car or traded it in.
However, you should 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. 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.
For example, let’s you bought a $30,000 car several years back and used it 100% for business driving. Because of the annual depreciation dollar caps, you still have a $16,000 basis in the car, which has a current value of $14,500. Now, you 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 the 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. For 2016, the allowance is 54¢ per business mile driven. The standard mileage allowance has a built-in allowance for depreciation, which must be reflected in the basis of the car. 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. All of this sounds very complicated, and it is. Before you sell or trade in your business car or lease a new one, please give us a call and we’ll set up a meeting to discuss your options.