Q:

Subject: Thanks and a Question

Kerry,

Just discovered your website today.  Very nice.  Thanks for the hours you must devote to keeping this up to date.

I found your site by researching a question on recapture rules for SUVs used in a business.  You’ve probably already thoroughly addressed this, but I’m afraid I couldn’t find the answer.  So, here’s the situation:

Client placed into service a large SUV (greater than 6,000 lbs gross vehicle weight) on 12/1/03.  He took advantage of the generous Section 179 election available back then, so has no basis left in the vehicle.

Business use has never dropped below 50%.  He is considering selling the vehicle, which has a current value of around $25,000.  Questions:

1.      What is the earliest date he could sell the vehicle without being exposed to recapture?  Is it 5 years from the in-service date (12/1/08)?

2.      Even if client waits long enough to avoid any recapture, is he still subject to tax on the sale?  If yes, is it capital gains or ordinary income?

3.      Client would prefer to lease his next business vehicle rather than trade this one in on another purchased vehicle. Is there a better way to get the next business vehicle? 

 

Thanks so much for your time.

A:

I have discussed the recapture rules on several occasions, which you can probably find by searching my blog. However, a quick review may be handy here.

For some reason, you seem to have the mistaken impression that it is possible to wait out the recapture requirements.  That is the case for the Section 179 recapture requirement while still owning the vehicle.  However, that is not possible for a sale.

It is always important to keep tabs on the adjusted cost basis (aka book value) of business assets so that you can know what any potential gain or loss would be triggered by its sale.

Basically, the book value is the original cost of the asset less the depreciation (including Sec. 179) claimed up to the point of sale.  In your case, if you expensed the entire cost of the SUV, its book value is zero, which means the full amount of any sales price will be taxable at the 25% Federal depreciation tax rate, plus state tax if you are in a taxable state.  This would be the case if the sale took place now or 50 years from now.

Before a sale, there is a potential taxable partial recapture of the Section 179 if the asset’s business usage slips below 50% in the first five years after you place it into service while still owning it.

If you are disposing of the SUV in order to acquire a newer model, there will be no taxable recapture if you trade in your existing one on the purchase of a new one costing at least as much as the old one is worth and you receive no cash or net relief of debt.

Replacing the SUV with one on an operating lease won’t qualify for any tax break.  A disguised purchase lease may qualify.

I have never been a fan of leasing from a financial perspective and have longed warned about how much of a rip-off it is.  With very few exceptions, I have found that operating leases of vehicles are by far the most expensive way to finance their acquisition; often incurring an implicit interest rate of well over 30% APR.  This is even before the exorbitant charges assessed by leasing companies for such things as excess mileage and excessive wear and tear. 

Unlike conventional vehicle loans, which are required to make full disclosure of the interest rates, leasing companies are allowed to camouflage their implicit rates and even lie about  what it is.  I have actually heard employees of leasing companies deny that there is any interest charge built into their monthly lease payments.  However, since any financially competent analyst can very easily compute exactly what those charges are, I have amazed clients with the truth about what they are being charged.  This is useful in saving them a lot of money when they ask for my advice before signing up for a lease; but is disheartening news when they tell mine about the lease after they have committed to it and are faced with the reality of how much they are being screwed over.  A lease with a 30% built-in interest rate simply doesn’t seem like much of a bargain compared to a purchase loan of zero to five percent.

These are all extremely basic tax and financial principles that any competent tax person should have no problem explaining to you and your clients; so before disposing of the old SUV or acquiring a new one, a tax pro should be consulted.

Good luck.  I hope this helps.

Kerry Kerstetter