What are capital gains taxes?
A capital gain is the profit an investor makes when they sell one of their assets. Investors then owe capital gains taxes to the government on this profit. When most people think of capital gains, they think of investments like stocks, cryptocurrencies, or bonds, but they can also apply to physical investments like real estate, fine art, and yes, cars.
Assets that are held for less than one year are considered short-term investments. Profits from these investments are taxed at the same rates as income tax. Assets held for longer than a year are considered long-term investments and are taxed at different (and usually more favorable) rates than short-term investments. Long-term capital gains are taxed at 0%, 15%, or 20%, depending on your overall tax bracket.
Are cars subject to capital gains taxes?
Many consumers think of cars as a functional purchase rather than a long-term investment. However, the IRS does consider profit from car sales to be a capital gain.
While this may sound daunting, most people who sell their cars never actually pay capital gains taxes. This is because cars depreciate very quickly and are sold at a loss in most cases. Since there is no profit in this case, capital gains taxes do not apply.
Capital gains taxes on cars are typically applied to classic or rare cars that have been purchased specifically for the purpose of investment. These cars have usually been meticulously stored, maintained, and upgraded to retain their value.
When are capital gains taxes due on cars?
If you do sell your car for a profit, you’ll need to pay capital gains taxes the year the sale is finalized. For example, if you sold a car during 2022, you would pay the capital gains taxes in spring 2023 when 2022 taxes are due.
When buying or selling any car, it’s important to keep documentation of the purchase price - even if you sell it at a loss. You will need this documentation for the IRS when you file your taxes.
Another key factor to consider is the improvements you’ve made to the car during the time you had it. Long-term improvements that add value, such as a new stereo system, can lessen your capital gains tax burden. For example, if you originally bought a car for $5,000, added a speaker system for $1,000, and sold the car for $6,000, you would apply the $1,000 in improvements to the original purchase price to break even instead of making a profit.
Of course, you’ll need to carefully document the money spent on these improvements to use this tax strategy. Regular maintenance like tire or brake replacements do not count as improvements.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
