Normally, when you sell a car it will be sold for significantly less than what you paid for it. This is especially true if you bought a newer car and sold it a few years later, given that newer cars depreciate rapidly.
However, when you buy an older car and fix it up with improvements, you may sell it for more than what you had originally bought it for. In this case, the IRS considers the result of this transaction a capital gain. And, unfortunately, capital gains are taxable.
For example, if you buy a car for $2,000, and then turn around and sell it for $5,000, the difference between the two amounts will be taxed at capital gains tax rates. In this case, that amount is $3,000.
However, if improvements (not repairs for normal maintenance) have been added to the car, then the dollar amounts of the improvements are added to the car’s basis (the dollar amount that it cost you to acquire the vehicle).
An example of an improvement would be anything new that is added to the car to increase its value instead of helping to keep it maintained like patching a crack in a windshield. This could be new tires, a new engine, etc.
If, after factoring in improvements, the sale of the vehicle is still showing a gain, the taxpayer will be required to report it on their tax return and pay tax on the gain.
Although the gain on the sale is taxable, that does not necessarily mean that you can deduct a loss. For business-use vehicles, the loss on the sale of a vehicle can be deducted against business income. However, for personal-use vehicles, you may not deduct the loss against your other income.
The good news is that capital gains tax rates are more favorable than ordinary income tax rates. Depending on your income, your capital gains tax rate will be one of the following: 0, 15, or 20%.
This article is not intended to tax, legal, or financial advice. For help regarding your specific situation, please consult a local professional.