Trade In Basis

[MariaMc]

I need help on calculating basis.

Old vehicle cost was $43,000 with accum deprec taken of $23,000 so cost basis of $20,000. There was still a $39,000 note payable on the car when it was traded in on a new truck.

The dealership gave them $40,000 trade in value and paid off the note. The buyer still had to come up with $14,000 to purchase new truck.

So the new cost basis is $34,000 to depreciate? I know there are rules on combining the cost basis or separately depreciating old basis and new basis. My main concern is whether the taxpayer is still allowed to depreciate remaining $34,000 although they only owe $14,000 on the new note.

[Bees Knees]

Use the trade in worksheet in TheTaxBook on page 10-2.

[MariaMc]

Tried that....

I already did the worksheet....that's why I came up with the answer I did. It just doesn't make sense to me that we are still deducting over $20k in cost basis on a vehicle that was traded in with the loan paid off by the dealer....it was basically a wash and the buyer upfronted another $14,000 to buy new truck.

[Bees Knees]

The worksheet on page 10-2 is for depreciation purposes only. You still have to report the transaction on Form 8824 and follow the like kind exchange rules.

Facts:
Old car cost = $43,000
Total depreciation allowed on old vehicle = $23,000
Loan on old car at trade in = $39,000
Total principal payments on old car loan = $4,000 ($43,000 original cost minus $39,000 remaining loan at time of trade in)
Trade in value of old car = $40,000
Equity in old car at trade in = $1,000
New truck loan = $14,000 (assume total principal payments are eventually made)
New truck cost = $15,000 ($14,000 loan + $1,000 equity from old car)

Under the auto trade in worksheet, potential total depreciation allowed assuming 100% business use on both vehicles = $57,000 ($43,000 cost of old car + $14,000 boot paid for new truck)

TTB worksheet on page 10-2:

Line 1 = $43,000
Line 2 = $23,000
Line 3 = $20,000
Line 4 = $14,000
Line 5 = $34,000
Line 6 = $23,000 (assume line 2 = 100% business use)
Line 7 = $0
Line 8 = $34,000

$23,000 depreciation for old car + $34,000 depreciation for new truck = $57,000. That doesn’t seem to make sense. How can you get $57,000 worth of depreciation deductions for only dishing out $18,000 in principal payments on the loans?

The reason is figuring depreciation allowed is only half the battle when doing a like kind exchange.

TTB, page 6-17 says:

Liabilities assumed. If one party in a like-kind exchange assumes
liabilities of the other party, the party that is relieved of
liability is treated as receiving cash in the amount of the liability.
If both parties assume liabilities, the liabilities are netted and the
taxpayer who is relieved of greater liabilities than those assumed
is treated as receiving cash.

In your example, a $39,000 liability on the old car was traded for a $14,000 liability on the new truck. Under the like kind exchange rules, that is $25,000 of liability relief ($39,000 minus $14,000). The taxpayer is treated as receiving $25,000 cash on the trade in.

Now let’s take those numbers, along with the other facts and fill out Form 8824, part III:

Line 15 = $25,000 (the net liability relief on the exchange of the old car for the new truck)
Line 16 = $15,000
Line 17 = $40,000
Line 18 = $20,000 ($43,000 original cost minus $23,000 depreciation allowed)
Line 19 = $20,000
Line 20 = $20,000
Line 21 = $20,000 (total realized gain on old car is due to prior depreciation allowed)
Line 22 = $0
Line 23 = $20,000
Line 24 = $0
Line 25 = $15,000

In essence, since liability relief exceeds the gain on the old vehicle, there is no deferral of gain under the like kind exchange rules. That does not mean this is not a like kind exchange. It is still a like kind exchange and you still can depreciate the new vehicle using the worksheet on page 10-2.

Reconciliation:

Principal payments on old car loan = $4,000 ($43,000 minus $39,000)
Principal payments on new truck loan = $14,000 (assume new truck loan is eventually paid off)
Total cash outlay on both transactions = $18,000 ($4,000 + $14,000)
Plus taxable gain on exchange = $20,000
Equals total cost to taxpayer = $38,000 ($18,000 cash paid on both loans + $20,000 taxable gain on exchange)

Total depreciation allowed on both vehicles under like kind exchange rules, assuming 100% business use = $57,000 ($23,000 + $34,000)

$57,000 depreciation minus $38,000 cost = $19,000 excess benefit.

The $19,000 represents depreciation allowed that does NOT need to be recaptured due to the like kind exchange rules. So even though you do have to recapture gain to the extent of liability relief, you do not need to recapture all of the potential depreciation allowed since this is a like kind exchange. If the new truck were eventually sold for cash, part of that excess benefit would be recaptured, but not necessarily all of it. That is the tax loophole of a like kind exchange.

Tax loophole:

This tax loophole can be illustrated this way. Forget about liabilities. Let’s assume cash only. I pay $10,000 cash for a new computer used for my business. Assume it is not subject to listed property rules. I take a $10,000 Section 179 deduction on it. One year later, I sell it for $10,000 cash and buy a new computer for $1,000. I pay tax on $10,000 worth of depreciation recapture on the sale of the old computer, and take the Section 179 deduction on the new one. Net cash paid = $1,000 ($10,000 cost of old + $1,000 cost of new minus $10,000 sale of old). Net depreciation = $1,000 ($10,000 Sec 179 on old + $1,000 Sec 179 on new minus $10,000 depreciation recapture).

Without the like kind exchange rules, net cash paid = net depreciation allowed.

Now let’s change one fact in my example. Instead of selling the first computer, I trade it for the new computer, and receive $9,000 cash boot ($10,000 FMV of old computer minus $1,000 FMV of new computer). Form 8824, Part III is filled out as follows:

Line 15 = $9,000
Line 16 = $1,000
Line 17 = $10,000
Line 18 = $0
Line 19 = $10,000
Line 20 = $9,000
Line 21 = $9,000 ($9,000 cash received minus $0 basis)
Line 22 = $0
Line 23 = $9,000
Line 24 = $1,000
Line 25 = $0

My cost is still $1,000 ($10,000 cost of first computer minus $9,000 cash boot on exchange for second computer).

But my net tax benefit now equals $2,000 ($10,000 Sec 179 + $1,000 Sec 179 minus $9,000 depreciation recapture).

Thus, the tax loophole under the like kind exchange rule is I get to defer paying tax on $1,000 worth of depreciation recapture from the old computer. I may never have to recapture that $1,000 if I use the second computer and then trash it.

This is similar to your situation. When you trade down for a lesser value asset under the like kind exchange rules, a portion of the depreciation from the old asset is carried over to the new asset in the sense that not all of the depreciation allowed needs to be recaptured.

[Gretel]

Thank you. Thank you. Thank you. I always dread an auto trade in because I have such a hard time grasping the whole concept in practice.

[gmack]

Sorry for resurrecting this thread but a search for “Like Kind Exchange” does bring this up near the top. I find this explanation of “auto trade-in” by Bees Knees extremely well explained and very helpful. However, there is one particular aspect that still troubles me.

“If one party in a like-kind exchange assumes liabilities of the other party, the party that is relieved of liability is treated as receiving cash in the amount of the liability. If both parties assume liabilities, the liabilities are netted and the taxpayer who is relieved of greater liabilities than those assumed is treated as receiving cash.”

I presume that, in this trade-in example, the parties involved would be the taxpayer and the auto dealer. Perhaps I am missing or misinterpreting something but I cannot see how the dealer could ever be construed as assuming liabilities. In most cases there will be a bank or other third party lender involved who has agreed to issue a loan to cover the net amount due to the seller. It does not matter to the lender if the purchaser is not getting enough for a trade-in to cover the existing loan. Therefore, the taxpayer will always be the one to assume any residual liability. For example: If the new vehicle price is $30k, and the loan balance on the old vehicle is $15k, and the dealer allows only $10k on the trade-in, that means the purchaser needs to borrow an extra $5k in order to work the deal. It does not mean that the dealer assumes a $5k liability. When all is done, the dealer will have: 1) a lien free trade-in vehicle and 2) a profit from the transaction. Am I wrong? Is it semantics?

[gmack]

No comments?

[Snaggletooth]

Cost of New Truck

Gmack, I don't believe the cost of the new truck was disclosed in the
original post. Like finishing a jigsaw puzzle with a piece missing.

[gmack]

Gmack, I don't believe the cost of the new truck was disclosed in the
original post. Like finishing a jigsaw puzzle with a piece missing.

Thanks Snaggletooth... With regard to my own question, the cost of the new vehicle is irrelevant. My point was that I cannot envision any situation under these circumstances where the taxpayer would be "relieved of a liability." He or she will need to make up any "trade difference" on the deal either by borrowing additional funds or paying cash.

[Snaggletooth]

Example Population

Gmack, with all due respect, an example with hypothetical numbers to calculate will crystallize one's thinking process into specifics and guide to arrive at an answer. If there are no quantitative numbers, a question can be answered but only in generalities.

I would think the original purchase price (before payoffs, trade-ins, etc.) would be extremely relevant.

Maybe I'm reading poorly or missing something...

Best regards, Snag

[gmack]

Snaggletooth,

Well actually, generalities are what I am looking for. I did use some examples in my first post, and I apologize that I am not explaining myself better, but my question is really a theoretical one of interpreting the tax regulations. In particular, the "like-kind-exchange" rules regarding liabilities assumed. Frankly, in all my years of trading in vehicles, I have never once been "relieved of a liability." Like I said, maybe it is semantics. I guess what I really want to know is "How does the IRS define being relieved of a liability?" When the deal is done, regardless of new price/old price/trade-in, I will be the one holding any residual liability (unless of course I pay cash).

Let's use those same numbers again... If I trade a vehicle with an existing loan balance of $15K for a new vehicle costing $30K and the dealer only gives me $10K, who is assuming the additional $5K liability? I assure you it is not the dealer... not in reality anyway.

I think I may be focusing to much on terminology. Looking at Bees example again; it looks like "liability relief" really means "newly calculated liability."

[Snaggletooth]

Liability

Gmack, unless your financial transaction history is extremely rare, chances are that you actually HAVE been relieved of a liability.

If you have traded cars, and your trade-in was secured by a bank loan, then the dealer would have HAD to pay it off in order to secure title rights. Being "relieved of a liability" simply means that you owed money to someone and then [poof!!] you no longer owe that party this money.

There are some people who trade cars and never have a payoff (i.e. they have a clear title to the auto being traded in). You may be one of these people but if this is the case, I assure you are a very distinct and lopsized minority.

I apologize if I am misunderstanding something...that does happen to me a lot...

[gmack]

Gmack, unless your financial transaction history is extremely rare, chances are that you actually HAVE been relieved of a liability.

If you have traded cars, and your trade-in was secured by a bank loan, then the dealer would have HAD to pay it off in order to secure title rights. Being "relieved of a liability" simply means that you owed money to someone and then [poof!!] you no longer owe that party this money.

There are some people who trade cars and never have a payoff (i.e. they have a clear title to the auto being traded in). You may be one of these people but if this is the case, I assure you are a very distinct and lopsized minority.

I apologize if I am misunderstanding something...that does happen to me a lot...

I think it is semantics... I do know what it means to be relieved of a liability...

I guess I am thinking in terms of the end result and the like-kind-exchange rules are, I am guessing, looking at each component as separate and distinct. If I pay off a $100 loan and make a new $100 loan in the same transaction, have I been relieved of a liability? The answer is both yes and no. So yes, the dealer may assume my liability but on a NET basis, and for form 8824, which treats the trade as one transaction, the dealer will never be left with a NET liability assumed. Correct?

[gmack]

Gmack, I don't believe the cost of the new truck was disclosed in the
original post. Like finishing a jigsaw puzzle with a piece missing.

You are correct here... I just read back and the cost of the new truck was not disclosed in the original post. I still think it is highly unlikely that the dealer would have a "Net liability assumed." Maybe Bees Knees will weigh in on this.