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Consider Trade-Ins to Defer Tax on Business Auto Sales

If you sell a business vehicle you normally will recognize ordinary income up to the lesser of the sales price or the amount of depreciation you previously claimed on the vehicle. This rule often surprises clients because vehicles are not appreciating assets the way real estate is (or once was). Fortunately, there is an easy way to defer the tax: trade-in the old vehicle rather than selling it. 

Unlike a sale, a trade-in of a business vehicle is considered a "like kind exchange" (also known as a "1031 exchange"). That means that there will be no tax on the trade-in allowance, but, in exchange for that benefit, you must reduce the basis of the new vehicle by the amount of the trade-in. As a result, your depreciation deduction for the new vehicle will be reduced and the gain will be deferred until the final vehicle is eventually sold (if ever). That can result in substantial tax savings. 

Sometimes, however, it may make more sense to sell the old vehicle outright. If the trade-in allowance is low or if you can fully expense the replacement vehicle in the year of purchase, you may be better off selling the old vehicle even though that will result in additional income. Thus, this is a transaction that calls for advance planning and some number crunching.