Think Twice Before Trading That Truck

Julie Dale, CPA-Austin

(correction 11-1-18)

Changes to the like-kind exchange rules in the Tax Cuts and Jobs Act (TCJA) will have a major impact on the vehicle trade-in process. Under prior law, trading a vehicle in on the purchase of another vehicle triggered the like-kind exchange rules and resulted in the deferral of any gain or loss recognized on the old vehicle. Now that like-kind exchanges are restricted to real estate only under the TCJA, there is no like-kind exchange treatment for vehicle trade ins.

For passenger automobiles used in businesses, this change will potentially result in a tax benefit. The limits placed on depreciation on these vehicles almost guarantee a loss will be recognized when traded in to purchase a new vehicle. This loss will now be recognized when it would have been deferred under the old rules. There are still other limitations that may defer current recognition, such as the passive loss or at-risk basis limits.

For business trucks, the law change will result in a tax liability that many will not expect. Trucks with a gross vehicle weight rating 6,000 pounds or more are not subject to the passenger automobile depreciation limits. This can lead to a potential deduction in the year of purchase equal to the total cost of the truck if bonus depreciation applies or a Section 179 election is made.

For example, a corporation purchases a 2017 Ford F-250 on Oct. 1, 2017 for $60,000. Since 100 percent bonus depreciation applies to this purchase, the corporation deducts the entire $60,000 as depreciation expense in 2017. On Oct. 22, 2018, the corporation trades the 2017 Ford F-250 in on a purchase of a 2018 BMW M5. The trade-in allowance given is $45,000. This results in ordinary income of $45,000 to the corporation on the trade-in allowance, an $18,000 depreciation deduction for the BMW, and a tax liability increased by $5,670 (21 percent of the difference). Under prior law, there would have been no gain recognized and no federal income taxes owed on this transaction.

This is a good example of why it is so important that taxpayers seek tax advice when considering a transaction even as mundane as trading in a vehicle. If this trade in was not truly necessary, then the tax bill of $5,670 could be avoided by seeking advice in advance. If the trade in was necessary, at least the corporation would be able to plan for the tax bill early instead of finding out when the 2018 tax return is prepared.

https://www.irs.gov/newsroom/the-highlights-of-tax-reform-for-businesses

https://www.irs.gov/newsroom/new-rules-and-limitations-for-depreciation-and-expensing-under-the-tax-cuts-and-jobs-act

https://www.irs.gov/businesses/small-businesses-self-employed/like-kind-exchanges-real-estate-tax-tips

Comments

[Patty Wyatt]

Rob, here is the author's general response; this is not to be considered tax advice. Please consult your tax professional if you have any questions.

The calculation proposed seems reasonable, but there are three main issues:

1. Consider whether the trade-in value reflects fair market value. If the dealer says something like “$5,000 minimum trade in” to get you to buy a new car, this could really be a discount on the new car rather than the fair market value of the old car.
2. Consider whether depreciation has been calculated correctly. Three issues—First, did he use standard mileage ever—if so, that includes a deduction for depreciation and he’s not allowed to claim depreciation separately then by shifting to actual. Second, did business use drop below 50 percent any year—if so, depreciation is calculated using straight line method. Third, was a contemporaneous vehicle log maintained to support the correctness of the allocation between business and personal use.
3. If there is a gain, consider depreciation recapture which would tax the gain as ordinary income rather than a capital gain to the extent of the gain to the extent of accumulated depreciation.

[Rob]

Hello,

If I trade in a vehicle that is 50% business, I use 50% of the value when it was purchased, and all the depreciation earned to compute my cost basis of the vehicle. Then I take 50% of the trade-in value, substrate from the cost basis, which will show the loss or gain, correct? So the process would like like this:

old vehicle purchase price x .50% - depreciation = cost basis

trade-in value x .50% -cost basis = loss or gain

Is this correct?

[David Slates]

I want to buy a $100,000 vehicle for business use. I have a personal vehicle that is worth $50,000 on a trade-in and would like to trade it in to save a few bucks on sales tax. However, I will not do so if it impacts the deductibility of the business vehicle purchase. Would I still get to deduct the full $100,000?

[Julie Dale]

Thank you for the comments! You are correct that I should have considered the Section 179/bonus on the new truck. My example would have been better with it traded in for a BMW sedan. Then the auto limits would kick in and there would be a true tax liability from the transaction.

[Ralph Preuss]

I agree with the recognition of the $45,000 gain on the trade, but they would also have the ability to offset that gain with bonus or Section 179 on the 2018 Silverado. So to say this trade would cause them to incur $9450 of taxes is not entirely correct.

[Ron]

Of course, they would still be able to deduct the cost of the Chevrolet, which will be at least as much as the trade in allowance for the Ford, which could reduce the self-employment tax, as the sale of the Ford would be on 4797. Couldn't this be a benefit anyway?

What am I missing?