Q. I own a limousine business. I have an offer from someone who wants to buy one of my older automobiles for about $10,000 more than Blue Book value. I’m inclined to accept the offer, but I’m worried I’ll have to pay a lot in taxes because the sale is so profitable. How can I estimate the taxes I’ll owe if I sell the car?
A. We’ll discuss this asset sale in the context of the sale of an automobile. However, the concepts we will describe would hold true for any asset sale, not just a car. Believe it or not, the taxes you’ll pay have nothing to do with the Blue Book value. Although we can understand why you might think that it would since it will feel like you made money if you sell for more than Blue Book value and it may feel like you lost money if you sold for less than Blue Book value.
In fact, you will pay taxes on the profit you make when you sell the car, but this profit isn’t calculated based on the Blue Book value. It’s calculated based on the Book Value of the car (your company’s books not the Blue Book). The profit you make when you sell a car is calculated as follows:
Profit = Amount for which you Sell the Car – Book Value of the Car
Book Value of the Car = Amount you Paid for the Car – Accumulated Depreciation on the Car
Profit = Amount for which you Sell the Car – (Amount you Paid for the Car – Accumulated Depreciation on the Car)
A couple of simple examples may help. Suppose you bought a car for $75,000 and sold it the same day for $80,000. You would pay taxes on the profit which would be $5,000 = $80,000 - $75,000 (there is no depreciation because you sold the car before you claimed any depreciation). I don’t know your tax rate, but let’s say it is 40% (to keep the math simple). Your tax on this transaction would be $2,000 = 40% of $5,000.
By the way, if you sold the car for $75,000, you would owe no taxes since you made no profit. Similarly, if you sold the car for $70,000 on the same day you bought it for $75,000 (not a great business deal), you would recognize a $5,000 loss which would reduce the taxes you would pay on the other profits of the business.
Now, let’s add the depreciation back into the equation with a new example. Consider a situation where you bought a car for $75,000. Let’s assume you kept the car for a number of years during which your accountant claimed a total of $25,000 of depreciation. This $25,000 of depreciation reduced your taxes during those years, but it also reduced the book value of the car. Therefore, the Book Value of the car (for tax purposes) is reduced by the cumulative depreciation. Accordingly, the Book Value of the car is $50,000 = $75,000 – $25,000. If you sold the car for $80,000, your profit on the transaction would be $30,000 = $80,000 – ($75,000 – $25,000) = $80,000 – $50,000. Therefore, if the tax rate is 40%, you would pay taxes of $12,000 = 40% of $30,000. Obviously, if you sold the car for $50,000 (its Book Value), you would not make a profit and would owe no taxes. Similarly, if you sold the car for less than $50,000, you would recognize a loss and create a tax reduction.
In summary, you can estimate the taxes you’ll have to pay on the sale of the car by subtracting the Book Value of the car from the price you are paid and multiplying the difference by your estimated tax rate.