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capital gains taxes on old cars

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Seems the IRS says a car is a "capital asset" not a collectible. From the Schedule D instructions: So is taxed as a capital gain, but not a gain on a "collectible."

 

Capital Asset

Most property you own and use for personal purposes or investment is a capital asset. For example, your house, furniture, car, stocks, and bonds are capital assets. A capital asset is any property owned by you except the following.

 

http://www.irs.gov/instructions/i1040sd

 

IRS Official Definition of a Collectible
Collectibles under IRC Sectioin 408(m)(2) include:

Any work of art,
Any rug or antique,
Any metal or gem (with limited exceptions, below),
Any stamp or coin (with limited exceptions, below)
Any alcoholic beverage, or
Any other tangible personal property that the IRS determines is a "collectible" under IRC Section 408(m).

 

http://www.irs.gov/retirement-plans/investments-in-collectibles-in-individually-directed-qualified-plan-accounts

 

Collectibles special tax rate

When collectibles are sold, they become taxable at a maximum tax rate of 28 percent. The tax applies to profit on the sale of your collectibles.

 

That tax rate is considerably higher than the average capital gains tax of 15 percent that most people pay for non-collectible investments such as stocks and bonds (the tax range for long-term capital gains is from 0 to 20 percent). The exception to this rule is that if you’ve held your collection less than a year before you sell it, your capital gain will be taxed as regular income.

 

http://1040return.com/collectibles-tax-collector/

Edited by mike6024 (see edit history)

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Thanks Mike.  I'm confident the  gain on a collectable car is taxed at the lower long term capital gain rate.


The thing I'm confused by is what happens when you are trading and how the paper gain basis transfers.

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John Draenas, a noted legal expert in the automotive field, writes a regular column in "Sports Car Market" magazine. Here are a few of his recent articles that might be relevant to the topic, although he's quick to point out that there is not certain answer for every situation.

 

In my business, I've obviously had many discussions about this with my father (and attorney), who made a 60-year career out of suing the IRS, and to make things as smooth as possible, his advice is to pay the higher rate and let the IRS sort it out--they have people on staff who check that sort of thing. While it's fun to think they're all dishonest thieves eager to get their hands on your money, that's really not the case. At the higher levels of audit, they check returns very carefully and if you are wealthy enough to be worried about cap gains on a collector car, then you're already being scrutinized at this higher level whether you know it or not. They aren't interested in stealing your money or keeping money that isn't due (because if you find out, you can sue them and get it back--with interest). But to avoid the hassles of enhanced scrutiny and perhaps an in-depth audit that will make mischief in other areas of your life, his advice is to pay the higher rate and let them sort it out so that you are the good guy and they are obligated to make things right by you. Since collectible automobiles are not quite settled case law in regards to whether they are capital assets or collectibles, it makes sense to not want to be the one paying to set the precedent for them in court.

 

Here are the articles by Draenas, which are a good overview.

 

https://www.sportscarmarket.com/columns/legal-files/tax-landscape-for-collectors

 

https://www.sportscarmarket.com/columns/legal-files/a-soft-market-and-hard-tax-choices

 

https://www.sportscarmarket.com/columns/legal-files/keeping-the-irs-away-from-your-cars

 

https://www.sportscarmarket.com/columns/legal-files/trading-cars-to-avoid-taxes

 

https://www.sportscarmarket.com/columns/legal-files/high-prices-high-taxes

 

Here is one line that seems particularly relevant and seems to at least be a variation on my father's advice:

 

Savvy collectors will report and use the 20% rate — but will also obtain a formal legal opinion ahead of time to support the filing. That way, if the IRS does challenge and establish that the 28% rate applies, you should be protected from filing penalties. A legal opinion is pretty cheap insurance, and the cost is deductible to boot. 

 

 

 

Edited by Matt Harwood (see edit history)

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Thanks Matt.  This has nothing to do with trying to lower a tax burden.  I'm just trying to understand the rules.   I have talked to a couple of dealers,  and even they don't seem to understand how a basis transfers (assuming it actually does) when trading.   I have always assumed that the 1031 code applied to the situation of selling,  then 3 months later buying and using the 1031 code to transfer your basis.  

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Well, yes and no. I've had clients ask me about the like-kind trades and the 1031 transfers (which are dead anyway) and the critical thing is that they have to be set up in advance. You can't sell a car today and buy one in three months and say, "Oh, this was a trade." The paperwork needs to be in place first, not after-the-fact. It's moot now. However, it is my opinion (and that's all it is) that If you are trading one object for some other object, then there's an established value that is equivalent to cash. Say you bought a Porsche Speedster for $40,000 twenty years ago and just traded it for a $200,000 Ferrari today. It is reasonable to assume that the Speedster's value was also $200,000 (not $40,000) and that there is tax due on that difference in value, which benefited you financially. Essentially you used the Porsche in lieu of cash, but for the same purpose, and in the eyes of the IRS, it's the same as income. This is where the gray area of whether an appreciating car is a capital asset or a collectible will come into play. Nobody seems to be able to say with any confidence either way, but as Draenas suggests, it might be good to get a lawyer to officially go on record as recommending the 20% rate, pay that, and let the IRS sort it out later (or pay the higher rate to be safe and also let the IRS sort it out). The key point here is that you owned something that became more valuable and used that increased value the same way you would have used cash. That counts as income and it has to be reported. The rate at which that income is taxed is the gray part.

 

Most trades in my business are guys trying to avoid sales tax, and that varies from state to state. Ohio, for example, does not allow an exception of trade value when it comes to sales tax. That is, if you buy a car for $50,000 and part of that is a trade-in worth $30,000, you still have to pay sales tax on $50,000 not just the $20,000 in cash that changed hands. Some states do allow such an exemption, and I would encourage buyers to check before, not after, they buy. 

 

For cap gains and the appreciation of an old car, it is still unsettled as those articles suggest, and if the sums are large enough, it will involve attorneys and accountants no matter which path you take. Obviously each situation is different and it will depend on the precedent being set (if any). I don't think a big enough fish has been fried for there to be a case that would set a precedent for all such cases, and I don't think any guy wealthy enough to be that fish is also dumb enough to try to cheat the IRS over 8% of a car's value. My guess is that this remains a gray area for the foreseeable future and that it will be handled on a case-by-case basis when the numbers are big enough to justify it and it will be ignored as long as nobody abuses it at levels too small to litigate.

 

It is always my personal and professional policy to just pay your taxes, both sales and income. Regardless of the argument about the injustice of having to pay sales tax on something others have paid sales tax on many times over, regardless of one's feelings about income taxes being theft, my 48 years of life with a tax attorney as a father suggests to me that paying your taxes will simply make your life easier. The IRS is relentless and they don't care about time. If it takes the careers of two separate agents to collect a past-due tax bill, well, they're willing to wait (my father spent more than 40 years litigating one case that required two generations of a family to conclude). The IRS will negotiate, but only as a last resort and not when they know they don't have to. And when they know you know you cheated, they will burn you to the ground to make an example of you. For many of them, it's sport. That's why his (and my) advice is to pay the going rate and sort it out later--you don't want to show up on the radar screen of the guys who burn people to the ground for fun.

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12 hours ago, mike6024 said:

Seems the IRS says a car is a "capital asset" not a collectible. From the Schedule D instructions: So is taxed as a capital gain, but not a gain on a "collectible."

 

Capital Asset

Most property you own and use for personal purposes or investment is a capital asset. For example, your house, furniture, car, stocks, and bonds are capital assets. A capital asset is any property owned by you except the following.

 

http://www.irs.gov/instructions/i1040sd

 

IRS Official Definition of a Collectible
Collectibles under IRC Sectioin 408(m)(2) include:

Any work of art,
Any rug or antique,
Any metal or gem (with limited exceptions, below),
Any stamp or coin (with limited exceptions, below)
Any alcoholic beverage, or
Any other tangible personal property that the IRS determines is a "collectible" under IRC Section 408(m).

 

http://www.irs.gov/retirement-plans/investments-in-collectibles-in-individually-directed-qualified-plan-accounts

 

Collectibles special tax rate

When collectibles are sold, they become taxable at a maximum tax rate of 28 percent. The tax applies to profit on the sale of your collectibles.

 

 

Much of the above it true but, non-collectible assets such as ordinary furnishings outside the realm of Louis XIV and such, are not taxable assets.

The difference being if you cannot declare a loss on something you also do not need to declare a profit.

In my case, on the 6 figure tractor,  I had a documented basis, reported the net gain and paid the tax at the regular long term capital gain rate.

I doubt there will ever be a better time to sell highly appreciated objects but honesty with the IRS is the best policy.

I understand prisons aren't the best accommodations....... :unsure:

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Like kind exchanges apply to business property.  Prior to the current law, trade ins of business property had basis incorporated in the new asset.  Not anymore.

 

The question would appear to be moot on two fronts.  Current law doesn't allow like kind exchanges for personal properlty (non real estate) or for non business assets.  

 

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So if I'm digesting all this correctly,  if I have a zero basis in a 20k car (all paper gain) and sell it for 10k and a car valued at 10k, I owe capital gains on the entire 20k.  Not just the cash part.

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38 minutes ago, alsancle said:

So if I'm digesting all this correctly,  if I have a zero basis in a 20k car (all paper gain) and sell it for 10k and a car valued at 10k, I owe capital gains on the entire 20k.  Not just the cash part.

 

That sounds correct(ish), but (but!) there might be an additional caveat there that the car you take in on trade isn't worth anything until you turn it into something else, either cash or another asset. The way my father always put it is that the government doesn't tax money sitting still, it only taxes it when it moves. If that car you took in on trade is something you're keeping and not selling for its $10,000 value right away, then it may have no current value in the eyes of the IRS because you haven't derived any financial benefit from it. However, when you sell it or otherwise gain financially from it, then it will be taxed. And again, there's another gray area as to whether it will be taxed at its current value or its value when you trade or sell it in the future, mostly likely the difference between the two as it becomes cap gains and your initial investment ($10,000) is factored into the equation. I don't know how far down this rabbit hole the IRS is willing to go to collect every penny, but when you take the car in on trade you will have to indicate some price paid for it on the sales documentation and pay sales taxes on some amount related to its acquisition. I would imagine that is the number they will use as the basis for evaluating your capital gains when you sell.

 

Does that make sense?

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1 hour ago, Matt Harwood said:

Does that make sense?

 

Yes, and what you are saying is where I started.  You only immediately pay the gain on the cash portion of the transaction.   To make it a really simple transaction,  what if I traded my 20k car with its 20k unrealized gain straight up for another car.  Would I owe capital gains on the 20k?  How would I determine the value of the transaction?   I think my car is worth 20k,  but maybe the guy I'm trading with thinks his car is worth 40k, but we still make an even swap.

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12 minutes ago, alsancle said:

 

Yes, and what you are saying is where I started.  You only immediately pay the gain on the cash portion of the transaction.   To make it a really simple transaction,  what if I traded my 20k car with its 20k unrealized gain straight up for another car.  Would I owe capital gains on the 20k?  How would I determine the value of the transaction?   I think my car is worth 20k,  but maybe the guy I'm trading with thinks his car is worth 40k, but we still make an even swap.

 

I don't believe a $20K-$20K swap is a taxable event because you haven't realized any gain despite the fact that you have $0 invested in getting that initial $20K car. You've traded one car for another car of equal value in the eyes of the IRS, even if experts know the car you took in was worth more. You have not turned it into cash and thus have not had any financial gain from it. I don't think the IRS has a way of knowing the value of the car you brought in beyond the fact that you decided it was worth $20K because that's how much the car you traded for it was worth (although if it is too lopsided on the back end, they might think there are some shenanigans afoot). If and when you sell the incoming car, you will pay the cap gains on any appreciation, which may include the fact that you paid nothing for the first car. Cars are assets, not currency, and simply holding one while it gets more valuable is not a taxable event and using one to "pay" for another is not necessarily financial gain at the time of the transaction. Fortunately, they haven't figured out a way to collect taxes on appreciation while a car is still in your possession. But when you sell the car you took in on trade, then the difference in value will likely be taxable.

 

Now whether you will pay taxes on the full $40K because your initial investment was $0 or if it will be the $20K difference between the trade value and the realized gain, I don't know. I suppose it's possible that one could keep trading up indefinitely and never pay cap gains on anything, but I also have to believe that the IRS has thought of this and has a mechanism to account for it. However, I don't know what that would be.

 

It's also possible that you could trade your $20,000 car for another car that would go down in value or would be damaged and worth considerably less when you sell it. I don't know how they would handle that initial $20,000 of "found" value (such as if the first car were inherited). I guess it would depend on how you came to own the car and what events led to that--if it was an inheritance, you might have to pay some tax on it at the time of acquisition. However, at that point, it might become tax neutral unless it appreciates significantly, and becomes cap gains. To be honest, they probably aren't going to chase small amounts--cap gains are typically reserved for large sums of money and is expressly designed to help the folks who simply move money from place to place for a living keep more of it. Applying it to collector cars is a tiny sliver of their revenue and probably one of the more difficult areas to police unless you're a mega collector with seven- and eight-figure cars moving around.

 

I'm going well beyond my area of expertise here. Trades and straight cap gains questions are pretty well established, but this esoterica is probably resolved on a case-by-case basis using the standard procedures of filing the return and letting the IRS contest it if they believe you have not paid enough. As Draenas says, a lawyer's opinion will probably shield you from penalties in that case--all you'd have to do is pay the difference because you acted in good faith with professional advice. Or pay the max and file an amended return at the lower rate later and see how they react.

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Thanks.  What you are saying is what I always assumed and my accountant has come around to that opinion also.   Obviously it is critical to document everything in the purchase and sale.  In theory you are not avoiding anything and will eventually have to pay the gain,  unless the market collapses or the car blows its engine, in which case you have bigger problems.

 

I think if you are lucky enough to trade a 20k for a 40k car,  and you sell it 12 months later you would probably be thrilled to pay cap gains on the 40k.

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Classic Car 1031 Exchange Example

The taxpayer owns a 1955 Maserati 200SI valued at an estimated $2,640,000. The first step is to visit with his CPA to determine the recognized gain or tax due once sold. The tax due can be deferred in a 1031 exchange given the replacement car or cars are greater than the 1955 Maserati 200SI. A QI is engaged to facilitate the exchange. A Purchase and Sale Agreement (PSA) is entered into by the taxpayer and the buyer including the following assignment language:

"Buyer is aware that Seller has the option to qualify this transaction as an Internal Revenue Code Section 1031 tax deferred exchange. Seller requests Buyer's cooperation in the event of an exchange and agrees to the assignment of this contract to Atlas 1031 Exchange, LLC by the Seller. Seller agrees to hold the Buyer harmless from any and all claims, liabilities and costs of such an exchange."

A qualified escrow account (QEA) is established under the taxpayer’s tax identification number requiring dual signatures for disbursement. If an earnest money deposit is received, the funds can be wired to the QEA prior to the closing to not be taxed upon closing. The QEA wire instructions are provided to the buyer for the balance of the funds. The car is transported to the buyer.

The taxpayer enters into PSAs for the replacement cars, provides EMDs from the QEA and formally identifies the replacement cars no later than the 45th calendar day post-closing. The replacement PSA must contain the following language:

"Seller is aware that Buyer has the option to qualify this transaction as an Internal Revenue Code Section 1031 tax deferred exchange. Buyer requests Seller's cooperation in the event of an exchange and agrees to the assignment of this contract to Atlas 1031 Exchange, LLC by the Buyer. Buyer agrees to hold the Seller harmless from any and all claims, liabilities and costs of such an exchange."

Prior to the exchange funds being wired to the seller, the wire disbursement authorization is signed by the QI and taxpayer. Funds are then wired to the seller and receipt of classic car. If  exchange funds are left over, they are wired to the taxpayer by the 181st calendar day post-initial closing.

A summary file of exchange agreements is then forwarded to the taxpayer and CPA in preparation of IRS Form 8824 on Like-Kind Exchanges.

If you are considering exchanging your classic or vintage car and have questions or want to engage Atlas 1031 Exchange, please click the button below .

1031 Exchange Consultation

Tags: classic car 1031 

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The 1031 is gone with the new tax law.  I was interested in what happens with a straight up trade where you have a paper gain on the car you are trading.

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Let's go back to the $0 basis as described by alsancle:  I can't think of such a situation, except as described further down.  An inherited car means the new owner pays no tax upon acquisition, but there should be an appraisal of all high-dollar items in the estate, and the car's value in the estate becomes the new owner's basis for future deaccession.  If the car is a gift, the acquisition value should be documented somewhere at the time by the new owner with a rationale, and that value becomes his/her basis for future tax calculation upon deaccession.  The donor of a gift may be subject to a Gift Tax if the value exceeds the applicable "per person, per year" limit.  The gift situation also includes the case of the farmer's widow who says, "you can have it if you get off my land."

 

Where it may get sticky is when one person adds another's (non-spouse) name to a title with a survivorship provision, so that when the first party dies, title automatically passes to the other without probate.  Frankly, I don't know which value the IRS would assign-- (1) value at time of adding the second party, or (2) value as of the date of death of the first party.  If I were the second party, I'd choose door #2.

 

I have personal knowledge of a surviving spouse selling a car which greatly appreciated in value during the couple's ownership.  An appraisal was done, almost a year later, of the four jointly-owned cars **as of the husband's date of death** and I paid the appraised price, and it was not a taxable event for the widow--because, like jointly owned real estate, the value was bumped up to FMV as of the date of the husband's death.

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Gain is calculated on the fair market value of what is received in exchange, whether it be cash or goods.  

 

At this point I feel obliged to make the following statement:  Nothing I have written is intended as tax advice applying to a specific transaction, nor may it be relied upon in preparing an income tax return.  I have not been engaged to provide advice and encourage anyone who needs advice to consult a qualified practitioner.  

 

My insurance agent is now happier.  

 

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After going back and forth with my accountant, it seems that the 1031 change impacts direct trades too.   So if you trade one car for another car you owe the capital gains in that tax year on the paper gain for your original car.

Edited by alsancle (see edit history)

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Selling for collection purposed 25 old blank garage invoices with carbon copies.. Garages in Texas and California. Out of business for at least a decade. $100.00

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42 minutes ago, Zimm63 said:

Believe thats what I said above.

 

 

You said nothing about the impact of the 1031 changes on when the tax money is due.

 

The 1031 changes are always talked about in the context of selling one car,  2 months later buying another and doing a like-kind exchange.   Nobody mentions the impact on pure trades which is significant.

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   IF I understand this correctly, after you purchase a car (with after tax s dollars), spend untold amounts of after tax dollars and untold hours of labour and after tax dollars on parts etc ... when you sell, you are expected to give the government  a “cut” .

   Sounds like a scam to me!

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9 minutes ago, bobcanuck said:

   IF I understand this correctly, after you purchase a car (with after tax s dollars), spend untold amounts of after tax dollars and untold hours of labour and after tax dollars on parts etc ... when you sell, you are expected to give the government  a “cut” .

   Sounds like a scam to me!

 

If I understand this correctly, you drive on those paved roads, don't get crushed by trucks because there are traffic signs and signals, and there's a police force to enforce them, and they have the temerity to ask you to help pay for it? Sounds like a scam to me!

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5 hours ago, alsancle said:

 

You said nothing about the impact of the 1031 changes on when the tax money is due.

 

The 1031 changes are always talked about in the context of selling one car,  2 months later buying another and doing a like-kind exchange.   Nobody mentions the impact on pure trades which is significant.

My final comment on this, as a CPA with 35 years experience.

 

1031 never applied to a personal vehicle, only business vehicles.  New law removes its application to business vehicles.  Done.

 

If you have a vehicle that is valued in excess of your basis (what you paid plus restoration costs, but not maintenance) you are very fortunate.  A legitimate strategy would be to hold onto it until you die, at which point your heirs would take possession with a basis equal to the fair market value at your date of death. 

 

Please provide me with your address, so I can send you a bill for the above.

 

Or, please ignore me and continue with your pursuit of the holy grail:  Gains free from tax.  

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