We get a lot of questions about vehicle deductions and there’s one thing that we really try to communicate to our clients when they are getting a new business vehicle. And that one thing is: SELL YOUR OLD VEHICLE!
Your business vehicle gives rise to gains and losses when sold to third parties. It works like this:
The original purchase price is your beginning basis.
- You divide beginning basis into business & personal use based on business mileage (vs. personal mileage).
- Depreciation reduces your business basis.
- Depreciation comes from either the depreciation tables or the IRS mileage rates.
- When you sell or your corporation sells the business vehicle, you compare the net business sales proceeds with the adjusted business basis to find your gain or loss.
For tax planning purposes, you need to know if your vehicle would produce a gain or a loss on the sale.
Example. Here’s how Bill Brown finds a $27,000 tax-loss deduction on his existing business vehicle. Mr. Brown has been in business for 11 years, during which he:
Converted his original personal vehicle into a business vehicle;
- Then traded in the converted automobile on a new business vehicle (car #2);
- Then traded in Car #2 on a replacement vehicle (Car #3); and
- Then traded in Car #3 for another replacement business vehicle (Car #4), which he is driving today.
During the 11 years Mr. Brown has been in business, he has owned four vehicles. Furthermore, he used standard mileage rates to take deductions for the business use of his vehicle. If Mr. Brown sells his mileage-rate-deducted business vehicle today, he realizes a deductible loss on the sale of $27,000.
The loss is the accumulations of 11 years of car activity during which Mr. Brown never cashed out, because he always traded in his old vehicle towards the purchase of his new one. Trades are considered IRC Section 1031 tax free exchanges. Unlike sales, where you cash out your ownership of the vehicle, trades defer the tax result to the next asset. That’s how Mr. Brown unknowingly accumulated this big deduction.
To get a mental picture of how this one sale produces a huge deduction, consider this: When Mr. Brown sells car #4, he is really selling four cars because the 1031 exchange rules pushed the old basis of each vehicle into the replacement vehicle’s cost-basis.
We’ve had clients with even bigger losses. One fellow earned a tax loss in excess of $100,000 on the accumulated build up of 5 luxury automobiles over a number of years.
Examine your car buying habits for this possible tax windfall. Have you been trading business vehicles? If so, your loss could be a big one. Is your current business vehicle really four cars for income tax reporting purposes? Do this examination soon – to take the loss, you would have to sell your car to a third party before the year ends.