In the “good ol days” (prior to 2017), when you went to trade in a used business vehicle for a newer one, you got to defer the gain on the disposal of the old vehicle, but it also shrunk the deduction you got for the purchase of a newer vehicle. Now, under the new TCJA (Trump Tax Law), when you trade in a vehicle, the transaction is treated as two events. One a sale and the other a purchase.
Let me give you some examples to help bring this into focus. Let’s say Fred has a business truck that he purchased over 4 years ago for $50,000 and he has taken 100% of that as a tax deduction in prior years. Fred’s tax basis in that old truck is $0. Fred wants to purchase a new truck for $65,000. He goes down to the local dealer and they will give him a trade-in allowance on the old truck of $25,000, Fred will pay an additional $35,000 to the dealer to close the deal and drive off the lot with a new truck, leaving that old beat up truck behind. (By the way, in this example, Fred’s new truck weighs more than 6,000 lbs Gross Vehicle Weight.)
Before 2017, Fred would get a bonus tax / section 179 deduction of $35,000 for the purchase of a new truck. (The purchase price of the new truck, minus the trade-in price of the old truck. $65,000-$25,000.)
Now in 2020, Fred would have to report the trade-in of the old truck as a sale. Remember his basis is $0 so 100% of the trade-in allowance of $25,000 is a taxable gain. Then, Fred gets to deduct the entire purchase price of the new vehicle in the year of sale under the bonus depreciation / section 179 expensing rules. So Fred gets a deduction of $65,000. The net impact on Fred’s tax return is a taxable income reduction of $35,000. ($65,000-$25,000.)
But Kelly! In the end, Fred gets the same deduction. What’s the big deal? My answer… What if Fred didn’t have a 6,000 lb truck, but a smaller vehicle weighing less that 6,000 lbs?
In the old world (prior to 2017), Fred would have gotten a net tax deduction of $11,160. In the brave new world of TCJA, it breaks down like this. Fred has the same taxable gain on the trade-in of the old truck…$25,000. The bonus depreciation deduction is limited to $18,000. Thus, now Fred’s net impact in the year of making this trade, is to have an INCREASE in taxable income of $7,000 ($25,000-$18,000). The good news is that Fred will get to deduct more of the cost of the truck in future years, eventually getting the whole deduction of the purchase price of $65,000 if he keeps it long enough. So, an argument could be made that eventually, Fred gets a tax deduction benefit of $35,000, it just takes longer than one year, as opposed to the old pre 2017 rules that got the entire tax benefit in one year.
Confused yet? Tax law is so much fun. Especially when Congress keeps changing it.
Have you heard? Proverbs 28:7a says, “Whoever keeps the law is a wise son…”