Posted by Abundant Wealth Planning LLC

Buying a New or Used Car & The Tax Implications

Buying a New or Used Car & The Tax Implications

When it comes to buying and selling a car, cutting out the middleman has many advantages. Buying a car from a private seller usually comes at a lower price. Selling one will make you more money than a trade-in, but buying or selling from a reseller also has its benefits, such as getting help calculating required tax payments.

Tax laws for the sale of used cars by individuals vary depending on the situation and state and, in some cases, even city. It may seem tricky to understand, but it is not an impossible task.

Do I have to pay taxes when I sell my car?

If, like most people, you want to sell your used car for less than what you paid for it, you don't have to pay sales tax. The Internal Revenue Service (IRS) treats all personal vehicles as capital goods. Selling this vehicle for less than the purchase price is considered a capital loss, which does not have to be reported on tax returns.

So if you bought the new car for $20,000, drove it for ten years, and are now looking to sell it for $7,000, the transaction should be straightforward, especially if you do it online. But if you bought an older vehicle cheaply, made improvements, and sold it for more than what you initially paid for, you'll have to report it to federal and state income tax returns, and you could be in debt.

Selling a vehicle for profit is considered a capital gain by the IRS, so you will need to report it on your tax return. But finding out the dollar value of that profit is not as simple as comparing the buying price with the selling price.

You will need to add the cost of the car upgrades to the original purchase price (shown on the invoice you received when you first purchased the car). An upgrade is something in the long run, like a new paint job, a new sound system, or improved mechanical components. It does not include the cost of regular maintenance, such as changing the oil or replacing the brake. Again, documents are important - it's best to have receipts detailing the cost of each upgrade to help you remember the exact numbers and use them as proof if needed. Tracking details makes it easy to check amounts with an online tax calculator.

If you spend $7,000 on a car and another $1,000 on improvements but sell the car for $7,000, this is considered a loss of capital, and you do not have to pay sales tax. But if the original selling price plus upgrades are $5,000 and you sell the car for $10,000, you will have to pay a capital gains tax of $5,000 on profits.

Do I have to pay taxes when I buy my car?

Yes, you have to pay vehicle sales tax when you buy a used car if you live in a state that applies sales tax. However, you do not pay this tax to the retailer or to the person who sells it. You will pay it to the state department of motor vehicles (DMV) when registering the vehicle.

The state in which you pay registration taxes is the state that collects sales tax, not the state in which you purchased the vehicle. So if you live in Massachusetts (a state with sales tax) but buy a car in New Hampshire (a state with no sales tax), you will still have to pay the tax in your state of origin, Massachusetts, when you receive the tax plates for the vehicle. Traveling out of state to purchase a used vehicle will not prevent you from paying state sales taxes. On the other hand, if you live in a tax-free state (Delaware, Montana, New Hampshire, Oregon, and parts of Alaska), you don't have to worry about paying outside state sales taxes if you travel out of state to buy your next car. Many states also allow local governments to collect local taxes. If you are buying a new vehicle in New York, for example, the total amount of sales tax on cars you will have to pay varies by city or county.

However, there are exceptions to the rule. Some states offer exemptions for out-of-state buyers and family transfers, gifts, and other special occasions. Contact your local automotive tax department. 

Bottom Line

Trading your car over to a dealership has its perks, including a nice tax cut, but selling it privately can get you more money. However, if you are selling a car, it is good to add up any upgrade costs and determine the car's total value; if you sell it for more than that amount, you will be subject to capital gains tax.

Plus, most buyers have to stay on a budget when looking for a new car. Therefore, it is important to understand your tax situation when deciding whether or not to sell your car to an individual.



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