Suppose you're in the market for a new business vehicle. You go down to the local showroom, kick the tires and try to wrangle the best deal. Normally, the dealer will agree to a trade-in value for your old car that reduces the cash you have to lay out for the new one.
Strategy: Before you jump into the deal, figure taxes into the equation. If you handle things correctly, you won't owe any current tax on the trade-in. But you'll need to adjust the new car's basis.
Depending on your situation, you might even jigger the trade-in value to achieve a better tax result. However, if you regularly replace one business car with another, you'll probably never write off the full cost of any of your cars. Plus, your annual deductions are still limited by the "luxury car" rules (see box below). So adjusting your basis up or down won't have much practical tax effect.
How to calculate new car's basis
Here's the skinny: If you trade in a business-use vehicle for another business-use vehicle, the transaction is treated as a "like-kind exchange" of property. So you'd pay no current tax if you complete the deal within the tax-law deadlines.
That means the new vehicle must be identified within 45 days of the trade-in, and you must receive it within 180 days (or your tax return due date, plus extensions, if that's earlier). If you don't receive a business car in exchange, you will have either a taxable gain or loss.
In a trade-in situation, the depreciable basis of the new vehicle is equal to (1) the adjusted basis of the old vehicle plus (2) any additional amount paid for the replacement vehicle minus (3) the excess depreciation you could have claimed if the vehicle was used 100 percent for business.
Example: How to adjust the basis
You bought your business car back in 2001 for $30,000. Now, you're upgrading to a fancier model costing $50,000. Let's say you've previously claimed $10,148 in depreciation deductions for the old car, based on your 80 percent business use. But if you had used the car 100 percent for business, it would have yielded you $12,685 in deductions. (For simplicity, we won't include any bonus
If you dispose of the car during the year, you will generally be entitled to a $710 depreciation deduction for 2005.
To compute the depreciable basis of your new car, start with your adjusted basis of $19,142 ($30,000 cost of old car, minus $10,858 in depreciation). Then add the additional $20,000 cost of the replacement vehicle ($50,000 new car cost minus $30,000). Finally, subtract the $2,892 in excess depreciation, based on 100 percent business use (a total of $13,750 in allowable depreciation minus $10,858 claimed). Result: Your new basis is $36,250 as shown below.
Although you have adjusted your basis upward, your depreciation deduction for the new car is still limited by the luxury car rules, as stated below. If you use your car 80 percent for business in 2005, for example, your deduction is equal to $2,368 (80 percent of $2,960).
Tip: Negotiate a higher trade-in value to reduce the sales tax on the new car purchase.
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