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.
As a general rule for a business vehicle:
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.
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.
The above example assumes you use the car 100 percent for business. If you use it less than 100 percent, 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.
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.
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