Tax Accounting IRS Depreciation
By: Glenn Schanel, CPA
on October 10, 2018

For decades, business vehicle trade-ins have been treated as like-kind exchanges. A like-kind exchange, also known as a 1031 exchange, allows business owners or investors to exchange like property for like property. Any gain that would have been recognized on an outright sale of the asset can be deferred, potentially for years, until the final property in a line of exchanges is sold.

Business owners have used this code to upgrade their business vehicles without worrying about a potential gain when the trade-in allowance from the dealer exceeded the depreciated cost of their old vehicle.

Tax Changes to Like-Kind Exchanges

Under the Tax Cuts and Jobs Act passed in December 2017, like-kind exchanges changed. Starting in 2018, section 1031 like-kind exchanges are limited to real property only. You can still exchange a rental property for another rental property, and defer the gain, but you cannot do the same with business vehicles.

You May Have Capital Gain

For example, let’s say that Shelly bought a new truck for her remodeling business in 2011. Thanks to bonus depreciation, that truck is now fully depreciated, and she trades it in for a 2018 truck that costs $48,000. Her dealer gives her a trade-in allowance of $22,000 for the old truck, and she pays the dealer $26,000.

Under the old law, Shelly wouldn’t recognize a gain on the trade. Her new truck would have a tax basis equal to the basis of the old truck ($0) plus the cash she paid ($26,000) for a total of $26,000.

Shelly has to treat the trade-in as if she had sold her old truck for the trade-in allowance of $22,000. Because the truck is fully depreciated, her business tax return will show a gain of $22,000. Her new truck has a basis of $48,000 — the total value she gave to the dealer.

You May Have a Loss

Let’s look at another example. Dennis is in sales and puts over 250,000 miles on his car every year. He trades in his car, bought for $45,000 two years ago, which now has a tax basis of $28,740. The dealer gives him just $20,000 towards his new car, which costs $50,000.

Under the old law, Dennis’ new car would have a tax basis $58,740 — the sum of the basis of his old car ($28,740) plus the additional $30,000 he paid the dealer, and he would recognize neither a gain nor a loss on the trade-in.

Under the new law, Dennis will recognize a loss of $8,740 ($20,000 – $28,740). His new car has a basis of $50,000.

Vehicles aren’t the only types of property impacted by the change to Section 1031. Previously, like-kind exchanges were allowed for intangibles like patents and franchise licenses, and for other types of personal assets such as livestock, artwork, machinery and equipment, airplanes, boats, and collectibles. Starting in 2018 only real property is eligible for like-kind exchange treatment.

The Tax Cuts and Jobs Act is a wide-sweeping change. We can help. Contact us before trading in your older business vehicle for a new model. We’ll help you figure out if that new car is really a good deal!

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