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How would I calculate Cost basis for a new vehicle used in

Customer Question
business, when the trade in...
How would I calculate Cost basis for a new vehicle used in business, when the trade in amount was insufficient to cover the loan balance on the old vehicle (I was upside down in my equity). The dealer included the pay off amount for my old vehicle in the calculation. I guess I don't understand the effect on basis when the dealer includes the payoff amount from the old vehicle into the loan on the new vehicle.

Thanks
Submitted: 8 years ago.Category: Tax
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11/24/2008
Tax Professional: Ed Johnson, Tax Preparer replied 8 years ago
Ed Johnson
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DearCustomer

 

Thank you for your question.

 

Do I understand correctly that you exchanged an old vehicle for a new vehicle?

 

That this appears to be a likekind exchange of equipment used in business?

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Customer reply replied 8 years ago
Yes... It is kinda complicated though, and I didn't "make the election" to repport it as such on my return (this is from my 2007 return) I have all the numbers and got it pretty much figured out I think. What through me off was the part about "treating assumed liability as cash received." If I do it that way, I would have a huge gain. But that can't be because my adjusted basis on the old vehicle is still $18,000 and I didn't even get enough from the trade to pay off the loan.
Customer reply replied 8 years ago
Old vehicle cost   $28,680
Amount Financed $28,586
Std mileage depreciation based on total miles driven (not just the business miles) $10,065

New vehicle cost   $32,508
Trade in allowed $12,647
Balance still owed on old vehicle $16,306
Extended warrantee   $1,200
Admin Fees $176
Deposit paid $1,000
Amont financed $36,394
Customer reply replied 8 years ago
I looked into filing an amended return to include the form 8824 but rules say something about it needing to be done "in a timely manner including extensions." So I guess there are really three components to this question... What is the effect of the car dealer including my loan balance from the old vehicle into the new loan? Is it to late to amend the 2007 return and do a like kind exchange? If so, can I just continue to depreciate the left over basis on the old vehicle?
Tax Professional: Ed Johnson, Tax Preparer replied 8 years ago

DearCustomer

 

Thank you for the information.

 

Since you did not take the election, then you can not treat it as a like kind exchange. (you already seem to know this). You can not amend a return to do the like kind exchange. It had to be designated befor the closing and you had to use a like kind exchange agent. You can not do it after the fact.

 

So the way this transaction should look is:

 

1. When you traded the old vehicle, the trade became the dispostion or sell price. So the Value of the trade in became your sell price. So you would report that sale on schedule D, and determine if it was a capital loss or capital gain. You would also be subject to paying recapture tax on any accumulated depreciation. IN most cases, where you experience a capital loss, your recapture tax is reduced or eliminated.

 

2. For the new vehicle, I assume the vehicle secures the total new loan, which included rolling over the payoff from the orginal vehicle. (let me know if this is not true).

 

Your cost basis for the new vehicle is the New vehicle cost: 32,508 dollars.

 

The new warranty and other fees including the old balance owed are loan expenses that have to be capitalized over the life of the loan.

 

 

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Customer reply replied 8 years ago
Thank You Mr. Johnson,
This makes perfect sense to me. The only part that confuses me now is the two options described in Pub 463 (for 2007 page 19).

“Car trade-in. If you traded one car (the “old car”) in on another car (the “new car”) in 2007,there are two ways you can treat the transaction.

1. You can elect to treat the transaction as a tax-free disposition of the old car and purchase of the new car. If you make this election, you treat the old car as disposed at the time of the trade-in. The depreciable basis of the new car is the adjusted basis of the old car (figured as if 100% of the car’s use had been for business purposes) plus any additional amount you paid for the new car. You then figure your depreciation deduction for the new car beginning with the date you placed it in service. Etc, etc…..

2. If you do not make the election described in (1), you must figure depreciation separately for the remaining basis of the old car and for any additional amount you paid for the new car. You must apply two depreciation limits (see Depreciation Limits, later). Etc, etc…

If you elect to use the method described in (1), you must do so on a timely filed tax return
This includes any payment to you for the (including extensions).

Otherwise, you must use the method described in (2)”

Etc, etc,….
In other words, track them separately.

Would (or could) option two apply here? Without having to file an amended return?

Thanks
Customer reply replied 8 years ago
Oh and to answer your question... Yes, the amount from the old loan was rolled over into the new loan.
Tax Professional: Ed Johnson, Tax Preparer replied 8 years ago

DearCustomer

 

thank you for the additional information. I did not quite get, apparently what you were getting at. BUT yes, you would treate it as option two...but you can give it the treatment I suggested.

 

However, as I re-read your question you were asking specifically about the basis.

 

IRS Publication 946 states an alternative that is better for you. (referred to 946 by publication 463).

 

.1. Treat the old vehicle as a disposition. as I already stated. BUT,

2. IRS code allows you to take the adjusted cost basis of the old vehlcle and continue to treat it as if it were placed into service, seperate from the new vehicle as of the date of the trade.

 

Remembe on property, you are taking a depreciation not deducting the loan itself.

 

Reference: http://www.irs.gov/pub/irs-pdf/p946.pdf

 

In your case, the vehicle you traded was underwater, so you have some additonal costs to take. That is why I recommended the first expensing method.

 

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Customer reply replied 8 years ago
Thank you Mr. Johnson,
I apologize for any confusion… Sometimes it is difficult for me to try and explain things without the benefit of a real time dialogue.
I probably gave you too much information but my initial question actually was about determining basis in a trade-in situation. I was pretty sure I had a handle on everything else but as I said, the IRS Pub has me confused. In particular, and I can’t remember which pub it came from, it says to treat any liabilities assumed by the other party as though it was cash received. However, it did not give an example of a trade-in situation where the car dealer pays off an existing loan. It said the amount realized was the FMV of the property received plus any cash received. This would mean my new vehicle price $32,000 plus the loan payoff amount $16,300 for a total of $48,300. Then subtract the basis of my old vehicle $18,063 to determine a gain of $30,237! This does not make any sense at all. I know I’m missing something here and, as I am thinking this through some more, it seems to me that first, the dealer is not actually assuming my liability because it is getting rolled up into my new loan. Second, I guess I need to figure my new loan disbursement as cash paid. Am I getting this right?

Thanks!

Thanks    
Tax Professional: Ed Johnson, Tax Preparer replied 8 years ago

Dear mwamey,

 

If its ok, I need to have someone take a fresh look at this, and I would like to refer you to another tax expert.

 

 

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Customer reply replied 8 years ago
OK... I should rephrase that the car dealer didn't actually pay off my existing loan, it was paid from the proceeds of my new loan.
Tax Professional: RD, Certified Public Accountant (CPA) replied 8 years ago
RD
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Since you did not elect to report this as a like kind exchange - you are going to have 2 assets on the depreciation schedule.

 

1. Old vehicle with the remaining cost basis $18,615(as it appears) and depreciate it over the remaining life. You may want to rename it to Old vehicle traded in for XYZ vehicle.

 

2. New vehicle - with cost basis equal to the basis over the old vehicle's carryover basis. Normally the basis in the property is the cost basis of the old property plus any additional amount you pay. Since the cost basis of the old asset is considered separately. The cost basis for new vehicle would be the additional amount you pay which is New Loan amount - the old loan amount taken over for the old vehicle. So the basis would be $36394 - $16,306 (which is the loan from the old vehicle) = $20,088 as this would be the loan pertaining to your new vehicle.

 

Note that no loss is recognized on this disposition. It is deferred until the new vehicle is disposed off.

 

Here is an extract from the publication 946 explaining this in detail-

If you acquire a passenger automobile in a trade-in, depreciate the carryover basis separately as if the trade-in did not occur. If the automobile acquired in the trade-in is qualified GO Zone property, the carryover basis is eligible for a special depreciation allowance. See Qualified Gulf Opportunity Zone Property in chapter 3. Depreciate the part of the new automobile's basis that exceeds its carryover basis (excess basis) as if it were newly placed in service property. This excess basis is the additional cash paid for the new automobile in the trade-in.

The depreciation figured for the two components of the basis (carryover basis and excess basis) is subject to a single passenger automobile limit. Special rules apply in determining the passenger automobile limits. These rules and examples are discussed in section 1.168(i)-6(d)(3) of the regulations.

Instead of figuring depreciation for the carryover basis and the excess basis separately, you can elect to treat the old automobile as disposed of and both of the basis components for the new automobile as if placed in service at the time of the trade-in.

 

Let me know if you have any question.

 

Please note: This advice is provided with the understanding that all the relevant facts have been provided by you. Any change in facts might affect the advice given and hence may not be relied on in such cases. Nothing contained in this reply was intended or written to be used, can be used by any taxpayer, or may be relied upon or used by any taxpayer for the purposes of avoiding penalties that may be imposed on the taxpayer under the Internal Revenue Code of 1986, as amended.

 

 

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Customer reply replied 8 years ago
Well... I'm not sure I followed that. I'm getting confused by the terminology (Excess basis vs carryover basis). Sounds like you are saying that even though I paid $37,000 for the new SUV, and I had $0 downpayment, the amount I can depreciate is only $20,088? and I have to ignore the $16,306 that I still owed?

When you say "Instead of figuring depreciation for the carryover basis and the excess basis separately, you can elect to treat the old automobile as disposed of and both of the basis components for the new automobile as if placed in service at the time of the trade-in" Isn't that the same as doing a like kind exchange?
Tax Professional: RD, Certified Public Accountant (CPA) replied 8 years ago

You are depreciating the total amount of $20,088 and $18,615 which is actually more than the cost of the new vehicle which is appx. $37K. This is because the loss on sale of the old vehicle is not recognized but is defered until you sell the new vehicle.

 

If this would not be a trade in situation than you would have taken the old vehicle out of the balance sheet reported the loss on sale of the old vehicle and recorded the new vehicle at $37K.

 

Regarding your other question-

 

 

"When you say "Instead of figuring depreciation for the carryover basis and the excess basis separately, you can elect to treat the old automobile as disposed of and both of the basis components for the new automobile as if placed in service at the time of the trade-in" Isn't that the same as doing a like kind exchange? "

 

Yes that is correct. It is like doing a like kind exchange. But since you did not elect that method, you cannot report it in this manner.

 

Let me know if you have any question.

 

Please note: This advice is provided with the understanding that all the relevant facts have been provided by you. Any change in facts might affect the advice given and hence may not be relied on in such cases. Nothing contained in this reply was intended or written to be used, can be used by any taxpayer, or may be relied upon or used by any taxpayer for the purposes of avoiding penalties that may be imposed on the taxpayer under the Internal Revenue Code of 1986, as amended.

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Customer reply replied 8 years ago
"Instead of figuring depreciation for the carryover basis and the excess basis separately, you can elect to treat the old automobile as disposed of and both of the basis components for the new automobile as if placed in service at the time of the trade-in"

Now I'm confused even more... Here you are saying I could do this.

I looked up section 1.168(i)-6(d)(3) of the regulations. This 14 pages of nonsense... LOL How can anyone figure out what that is saying?
Tax Professional: RD, Certified Public Accountant (CPA) replied 8 years ago

You could do the above(as stated by you in your question) if you elected to report it as a like kind exchange.

 

But since you did not elect to report it as like kind, you will report it in the manner posted in my post earlier.

 

I do understand that this is confusing.

 

Let me know if you have any question.

 

Please note: This advice is provided with the understanding that all the relevant facts have been provided by you. Any change in facts might affect the advice given and hence may not be relied on in such cases. Nothing contained in this reply was intended or written to be used, can be used by any taxpayer, or may be relied upon or used by any taxpayer for the purposes of avoiding penalties that may be imposed on the taxpayer under the Internal Revenue Code of 1986, as amended.

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Customer reply replied 8 years ago
So is there any way to fix this going forward? Or will I need to file an amended return? I already took depreciation on the full cost of the new SUV. I will need to go back and refigure on two assets instead of one.

This is from Pub 463 "For information on how to figure depreciation for cars involved in a like-kind exchange (trade-in) in 2007, for which the election was not made, see Publication 946 and temporary regulations 1.168(i)-6T(d)(3)"

This implies that there is a method or process to deal with a situation where the "election was not made." But it is impossible to understand this 14 pages of double talk. I assume the only way to deal with this now is to file an amended return.
Tax Professional: RD, Certified Public Accountant (CPA) replied 8 years ago

I would suggest you to calculate the depreciation as discussed in my post. To the best of my belief the depreciation calculated by you and the depreciation based on the method I suggested would almost be the same. If the depreciation claimed by you is more that what is should be using the method as discussed than you may want to amend the tax return and report the correct depreciation amount.

 

 

Let me know if you have any question.

 

Please note: This advice is provided with the understanding that all the relevant facts have been provided by you. Any change in facts might affect the advice given and hence may not be relied on in such cases. Nothing contained in this reply was intended or written to be used, can be used by any taxpayer, or may be relied upon or used by any taxpayer for the purposes of avoiding penalties that may be imposed on the taxpayer under the Internal Revenue Code of 1986, as amended.

 

RD
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Customer reply replied 8 years ago
OK… This is definitely a complex issue and I’ve gotten some really good advice. It is ridiculous how complicated the tax law is in this situation. I searched for two days, following a trail of material through several publications and regulations. Regulation 1.168(i)-6T(d)(3)” amounts to 14 pages of incomprehensible “double speak” and “circular references.” Thanks to the expert direction I got from Ed Johnson and “RD,” I was able to follow the concept and I now understand how the tax law is applied to this situation. I hate to do an amended return, but it would be to my benefit since last year would result in a small refund, and I would also get the extra depreciation in the years going forward.

Thanks for the help!
Tax Professional: Ed Johnson, Tax Preparer replied 8 years ago

Dear mw,

 

Thank you for your comments and feedback.

 

When you accept the answer, please accept on RD as I opted out and he gets the payment.

 

Best Regards

 

Ed

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