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Business cars: Swing the best tax deal on trade-ins

by on
in Small Business Tax,Small Business Tax Deduction Strategies

Suppose you’re in the market for a new business vehicle. So, you go down to the local showroom, kick the tires and try to negotiate the best deal possible for a replacement.

Normally, the dealer will agree to a trade-in value for your old auto that reduces the cash you have to shell out for the new one.

Strategy: Figure taxes into the equation before you sign the papers. If you handle it well, you won’t owe any current tax on the trade-in, although you’ll still have to make certain adjustments in the new car’s basis.

Depending on your situation, you might even jigger the trade-in value to lock in a better tax result.

If you replace one business car with another on a regular basis, though, you’ll probably never write off the full cost of any of your cars. Plus, your annual deductions are generally limited by the “luxury car” rules. So, most of the time, adjusting your basis up or down doesn’t have much practical tax effect.

Here’s the deal: If you trade in a vehicle used for business driving for another business-use vehicle, the transaction qualifies as a “like-kind exchange” of property. So, you pay no current tax if you complete the deal within tax-law deadlines:

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’ll realize either a taxable gain or loss.

In a trade-in situation, the basis of the new vehicle for depreciation purposes equals:

The adjusted basis of the old vehicle.

Plus any additional amount you pay for the replacement vehicle.

Minus the excess depreciation you could’ve claimed if the vehicle was used 100 percent for business.

See the box below for an example of to how to figure your basis.

Luxury-car limits: Don’t cross the line

The luxury-car limits apply to business cars costing more than $14,800. Furthermore, you must reduce the annual dollar caps according to your percentage of business use.

Here are the depreciation limits for a car placed in service by Dec. 31:

First year......................... $2,960

Second year...................... 4,800

Third year......................... 2,850

Each succeeding year........ 1,775

Tip: You can’t overcome the luxury-car limits by using the Section 179 expensing deduction. So, you’re usually better off saving the current write-off for other business assets.

Example: How to figure your basis

Let’s say you bought your business car back in 2003 for $30,000. Now, you’re upgrading to a flashier model that costs $50,000.

You’ve claimed $10,148 in depreciation deductions for the old car based on 80 percent business use, although 100 percent business use would have yielded $12,685 in deductions. (For simplicity, we won’t include any bonus depreciation deduction for post-Sept. 11 purchases or any Section 179 expensing allowance.)

If you dispose of the old car midway through the year, you’ll be entitled to a $710 depreciation deduction for 2006.

To compute the basis for your new car, start with your adjusted basis of $19,142 ($30,000 cost less $10,858 total in depreciation). Then, add the additional $20,000 cost ($50,000 less $30,000) of the replacement vehicle. Finally, subtract the $2,892 in excess depreciation based on 100 percent business use (a total of $13,750 in allowable depreciation less $10,858 claimed).

Result: Your new basis is $36,250, as shown below.

Cost of old car........................ $30,000
Less depreciation claimed........ (10,858)
Adjusted basis of old car........... 19,142
Plus additional amount paid....... 20,000

Subtotal.................................. $39,142

Excess depreciation based
on 100 percent business use..... ($2,892)

Adjusted basis of new car..... $36,250

Although you’ve adjusted your basis upward, your depreciation deduction for the new car is still limited by the luxury-car rules. If you use your car 80 percent for business in 2006, for example, your deduction equals $2,368 (80 percent of $2,960, the first-year depreciation limit).

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