Maximizing Tax Deductions On Your Company Car

By: Bruce Legawiec, CPA, Partner

Time for a new company car? Be sure to consider the tax consequences of “trade-in” versus “for sale” vehicles. 

A common and general universal deduction for any business activity is that of a company car. A company car may be that everyday vehicle used for travel, it may be a service or delivery vehicle, or a vehicle used at the plant facility, or perhaps on the farm. In each category, there may be slight nuances for record keeping requirements, method of depreciation, life of vehicle and perhaps W-2 reporting for personal use of the vehicle. There is however, one common tax treatment of all vehicles (and for that matter, all business assets) that often gets overlooked - and if the wrong choice is made, the result will be a delay in claiming a significant current tax deduction on the disposition of the car.

Most people are aware that Section 1031 is often used in real estate transactions to defer gain when one piece of real estate is “exchanged” and replaced with another piece of “like kind” property. However, many people do not realize that Section 1031 applies to all business assets. Anytime one business asset is exchanged for another business asset, Section 1031 must be applied.

However, the application of section 1031 on exchange of business assets is not always a favorable tax result. Keep in mind 1031 is a “deferral” on the recognition of “gain” or “loss” on the exchange of one business asset for another like kind business asset.

Here is how this can happen. The reality is that most vehicles depreciate in the open market much faster than the depreciation that is allowed in the IRS tables. The result is that the trade-in value will be less than Net Book Value (NBV). Since “trade-in” value is less than NBV, this results in an accounting loss. However, because the trade-in is a like kind 1031 transaction, the “loss” is not allowed currently but it is deferred and added to the tax basis of the replacement vehicle.  If the difference between trade-in allowance and NBV is for example, $10,000, the trade-in will result in delay of a $10,000 business deduction. 

Key to this situation, before you trade in any vehicles for replacement vehicles, check the NBV of the exchange auto. If the trade-in value is less than the NBV, rather than trade-in the vehicle (generating a deferred loss that cannot be used currently), you will be better off (from a tax perspective) to sell the vehicle, generate a tax loss that can be deducted, then use the proceeds as a down payment on a new vehicle.  Keep in mind, the sale must be to an unrelated party to claim the loss.  

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