Cars, trucks, and construction equipment are an essential part of many businesses, especially construction and service companies. Company owners often elect to expense part or all of the initial cost of their vehicles and equipment through Section 179 or bonus depreciation, which provides some advantageous year-of-purchase tax planning opportunities. But what happens when the vehicle or equipment is no longer needed, when it will be traded in or turned over to an owner for personal use?
When selling a vehicle or equipment, the business will end up with a gain or loss for tax purposes depending on the remaining un-depreciated value as compared to the sale proceeds. Most think when selling an asset, they will recognize a capital gain or loss. However, this is often not the case when selling business property.
In general, the “character” of the gain depends on the amount of depreciation taken on the business asset. Should the calculated gain be less than the overall accumulated depreciation at the time of sale, the gain would be taxed at ordinary income rates, up to the highest prevailing rate in the year of sale—for 2021, 37 percent. If the gain were to exceed the depreciation taken, it is capital and taxed as a short- or long-term capital gain depending on the holding period (more than a year is considered long-term). If a loss occurs, that loss can be recognized as an ordinary business deduction.
Most businesses trade-in a vehicle or piece of equipment in exchange for a newer, better model. Prior to 2017, owners enjoyed the deferral of gain on a trade-in under “like-kind” exchange rules. The owner’s basis in the new vehicle was reduced by the gain on the old vehicle, thus delaying the taxability of that vehicle until it was ultimately sold. But the Tax Cuts and Jobs Act (TCJA) of 2017 removed the like-kind exchange rules for personal property. Businesses now recognize a gain or loss on the old vehicle by comparing the trade-in value afforded by a dealership to the un-depreciated value of that vehicle. Once the gain or loss is determined, the rules for a sale apply to determine its character.
Distribution to Owner
There are tax considerations for an owner taking possession of a company vehicle or piece of equipment or giving it to a family member. The tax treatment of that distribution will first depend on the company’s tax structure; an S or C corporation is treated differently than sole proprietorships and partnerships:
- For corporations, the distribution of the asset results in a deemed sale for fair market value and therefore, possibly, a taxable gain. The fair market value must be calculated in some reasonable manner to help determine any gain or loss. Then the rules of selling the asset come into play with one significant exception: If the deemed sale results in a loss, the loss is disallowed for tax purposes if the recipient owns more than 50 percent of the business, directly or indirectly. While the owner is required to pay tax on any gain, he or she is unable to deduct the loss. If there is a gain on the distribution, then the taxation is the same as a sale, the only difference being the use of estimated fair market value as the sale proceeds.
- For sole proprietorships, the distribution may or may not require recapturing some depreciation when a business-use asset is converted to a personal asset. If recapture is required, the distribution is taxed at the highest prevailing rate in the year of distribution.
- For partnerships, the distribution may require recapturing some depreciation, but there would be additional questions to answer: Was the property contributed? If so, by which partner? How long was the property held by the partnership? Is the distribution to the same partner that contributed the property? Was the asset purchased by the partnership? Is the distribution of the contributed property to another partner? With partnership taxation, unlike corporations, the questions increase in number and the transaction increases in complexity.
It is always smart to contact your trusted advisor when selling, trading in, or distributing company-owned vehicles or equipment to an owner. Ask what is best for the business, when the transaction should occur, whether a sale or trade-in should even be contemplated, and how the distribution of the asset will affect the owner. If you wait until after the transaction, you may have no options for reducing or deferring taxes.
Contact your HBK Tax Advisor if you would like more information at 772-287-4480.