Should You Sell or Trade in Your Vehicle?

You need to consider the tax impact of selling your vehicle outright and buying another vehicle in a separate transaction or trading in your old vehicle for another.

Personal-use Property vs Business-use Property

Keep in mind, a loss incurred on the disposal of personal-use property is not deductible unless the loss was the result of a casualty or theft. However, a gain on the disposal of personal-use property is taxable.

A loss on the disposal of business-use property, on the other hand, is deductible and a gain is taxable.

For example, say you sold a vehicle that you used 80% for business and 20% for personal use and that you incurred a loss. You may deduct 80% of the loss against business income. The other 20% related to personal use is not deductible.

If you sold the vehicle at a gain and used the vehicle 80% for business and 20% for personal use, 100% of the gain is taxable.

When disposing of your old vehicle and buying a replacement, you can elect to treat the transaction as either a taxable sale or nontaxable exchange.

Taxable Sale:

  • This is when you sell your old vehicle in one transaction, then buy another one in a separate transaction.

Nontaxable Exchange:

  • This is when you trade-in your old vehicle for a replacement.

Taxable Sale of a Car Used for Business

If a loss would result if you sold your old vehicle, you're better off just selling it outright rather than trading it in because you can deduct the loss in the year of sale and reduce your taxes.

A loss would occur if the adjusted basis of old vehicle exceeds what you could sell it for (its fair market value).

Nontaxable Exchange (trade-in old vehicle)

When You Should Trade In Your Vehicle:

  • If a gain would result if you sold your old vehicle outright, you're better off trading it in. This is because you can defer (postpone) reporting the gain by trading it in (exchanging it) for another vehicle. You don't report the gain on a trade-in.

A gain occurs if...

  • the fair market value of what you receive exceeds the adjusted basis of the vehicle you trade in plus any additional amount you pay for the new vehicle.

Example:

  • You trade in your old vehicle with an adjusted basis of $3,000.
  • The fair market value (FMV) of the new vehicle is $7,500.
  • The dealer allows a $3,500 trade-in allowance for your old vehicle.
  • You pay $4,000 cash for the new vehicle (FMV of new vehicle $7,500 minus $3,500 trade-in allowance).

Your gain is $500.

Figured as follows:

  • FMV of $7,500 (new vehicle) minus
  • $7,000 ($3,000 adjusted basis of your old vehicle plus
  • $4,000 cash you paid) equals
  • $500 gain.

The depreciable basis of the new vehicle is $7,000.

Figured as follows:

  • Cash you paid, $4,000 plus
  • Adjusted basis of the old vehicle, $3,000.

The $500 gain on the trade-in is deferred because it reduces the basis of the new vehicle. If you sold the new vehicle the next day for $7,500, you would recognize the $500 gain at that time ($7,500 minus your adjusted basis of $7,000).

In a nontaxable exchange the rules are:

  • No gain or loss is recognized
  • Treat the old vehicle as disposed of at the time of the trade-in.
  • The depreciable basis of the new vehicle is the basis of the old vehicle traded in, plus any cash you pay and any other costs to you to acquire the new vehicle.

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