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Two items concerning trade-ins on new cars and trucks come to mind. The first is
a new idea – a government voucher for use in buying a new vehicle for which most
of us will not qualify. The second is an old, but helpful, idea for those of us
with tax deductible depreciation for the business use of a vehicle.
“Cash for Clunkers”
The purchaser of a new car or truck
trading in an eligible vehicle between July 1 and November 1, 2009 might receive
a voucher from the federal government of up to $4,500, depending on the type of
vehicle being traded in and the fuel efficiency of the vehicle being purchased.
Only new cars and new trucks qualify. The trade-in must be in drivable
condition, and the same owner must show continuous insuring and registration of
the trade-in vehicle for at least one year prior to the trade-in date. The
trade-in vehicle must be less than 25 years old with a fuel efficiency of less
than 18 miles per gallon. The new vehicle must have a “EPA window sticker
mileage” rating of at least 22 miles per gallon for passenger automobiles. For
light-duty passenger trucks, the old vehicles must be rated at 18 miles per
gallon or less and the new light-duty truck or SUV must achieve fuel efficiency
of at least two miles per gallon more to qualify for a voucher worth $3,500 and
must achieve five miles per gallon more to receive the full $4,500 voucher.
Participating new car dealers (used
cars are not eligible) will apply a credit reducing the price the purchaser pays
at the time of purchase or lease, providing the trade-in vehicle meets the
program requirements. The dealer will then obtain reimbursement from the
government. Only new vehicles with a manufacturer’s suggested retail price of
$45,000 or less are eligible for the $3,500 to $4,500 credit.
The law requires that the trade-in
vehicle be destroyed. Accordingly, the purchaser should not expect to get full
value for the trade-in vehicle as the dealer can only realize the scrap value on
the trade-in.
In summary, the program might be
useful to those who want to buy a new vehicle with a manufacturer’s suggested
retail price below $45,000 and who have owned the trade-in vehicle for more than
one year prior to the trade-in date. The details of the program and some helpful
questions and answers are at the government’s website www.cars.gov.
The Trade-In Trap
Taxpayers who use a vehicle in a
trade or business might find it better to occasionally sell
the old business |
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vehicle than to trade it in on a new business vehicle because of the “luxury
car” depreciation limitations. Congress generally defines a “luxury car”
in the Internal Revenue Code as one costing more than $14,800 and imposes an
annual limitation on tax deductible depreciation that is less than economic
depreciation. A taxpayer who has successively traded in several business
vehicles of relatively high initial acquisition cost will, because of the
depreciation limitations, have a tax basis in the current vehicle that is
probably greatly in excess of the vehicle’s fair market value. For example, a
taxpayer who has over a period of nine years purchased three cars, each
originally costing $40,000 and having a trade-in value of about $18,000, will
have a tax basis of $46,970 in the third car at the end of its third year of
ownership. The third car in this example at trade-in would be three years old
and might be expected to have a fair market value of about $18,000, or $28,970
less than its tax basis. Trading the car in would defer the recognition of this
loss to the basis of the fourth car. Selling the car to an unrelated party
(which can normally be arranged with the dealer) would trigger the current
recognition of this loss and would result in an ordinary tax deduction that
would save income taxes of $11,588 for a 40 percent marginal bracket taxpayer.
This income tax savings is, however,
partially offset by increased sales tax on the new vehicle equal to the sales
tax rate times the value of the old vehicle. In other words, sales tax on a new
vehicle with a trade-in is paid only on the cash difference. In the case of
outright purchase of the new vehicle, sales tax is paid on the entire purchase
price. In our example above, selling rather than trading the vehicle in would
cause additional sales tax at 8.6 percent of approximately $1,550, resulting in
a net tax savings of about $10,038.
In our example above, we have also
assumed a business-use of 100 percent, which is the norm for corporate vehicles,
but is very rare for vehicles owned by individuals. For vehicles with less than
100 percent business use and for lower-priced business vehicles, the tax savings
on the sale will not be as dramatic. Regardless of a vehicle’s cost or business
use percentage, however, consideration of the income tax consequences of selling
versus trading is usually worthwhile for every other vehicle acquisition.
We will be happy to discuss sale
versus trade-in or any of your questions on business vehicle deductions. |
