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1. You can elect to treat the transaction as a tax-free disposition of the
old car and the purchase of the new car. If you make this election, you
treat the old car as disposed of at the time of the trade-in. The
depreciable basis of the new car is the adjusted basis of the old car
(figured as if 100% of the car’s use had been for business purposes) plus
any additional amount you paid for the new car. You then figure your
depreciation deduction for the new car beginning with the date you placed
it in service. You make this election by completing Form 2106, Part II,
Section D. This method is explained later, beginning at Effect of trade-in
on basis.
2. If you do not make the election described in (1), you must figure
depreciation separately for the remaining basis of the old car and for any
additional amount you paid for the new car. You must apply two depreciation
limits (see Depreciation Limits, later). The limit that applies to the
remaining basis of the old car generally is the amount that would have been
allowed had you not traded in the old car. The limit that applies to the
additional amount you paid for the new car generally is the limit that
applies for the tax year, reduced by the depreciation allowance for the
remaining basis of the old car.
You must use Form 4562, Depreciation and Amortization, to compute your
depreciation deduction. You cannot use Form 2106, Part II, Section D. This
method is explained in Publication 946.
If you elect to use the method described in (1), you must do so on a timely
filed tax return (including extensions). Otherwise, you must use the method
described in (2).
Effect of trade-in on basis - The discussion that follows applies to
trade-ins of cars in 2006, where the election was made to treat the
transaction as a tax-free disposition of the old car and the purchase of
the new car. For information on how to figure depreciation for cars
involved in a like-kind exchange (trade-in) in 2006, for which the election
was not made, see Publication 946 and Temporary Regulations section
1.168(i)-6T(d)(3).
Traded car used only for business - If you trade in a car that you used only
in your business for another car that will be used only in your business,
your original basis in the new car is your adjusted basis in the old car,
plus any additional amount you pay for the new car.
Example 1. Paul trades in a car that has an adjusted basis of $5,000 for a
new car. In addition, he pays cash of $20,000 for the new car. His original
basis of the new car is $25,000 (his $5,000 adjusted basis in the old car
plus the $20,000 cash paid). Paul’s unadjusted basis is $25,000 unless he
claims the section 179 deduction, or has other increases or decreases to
his original basis.
Example 2. In October 2003, Marcia purchased a car for $26,000 and placed
it in service for 100% use in her business. Marcia did not claim a section
179 deduction but she did claim the special depreciation allowance.
Marcia’s unadjusted basis for the car was $15,290 ($26,000 - $10,710 (50%
special depreciation allowance up to the maximum amount allowed)). For 2003
through 2005, Marcia figured her depreciation deduction using the MACRS
depreciation chart for those years.
In September 2006, Marcia traded that car in and paid $14,200 cash for a
new car to be used 100% in her business. Marcia is allowed one-half of the
MACRS depreciation amount figured for 2006 for her old car.
Traded car used partly in business - If you trade in a car that you used
partly in your business for a new car that you will use in your business,
you must make a “trade-in” adjustment for the personal use of the old car.
This adjustment has the effect of reducing your basis in your old car, but
not below zero, for purposes of figuring your depreciation deduction for
the new car. (This adjustment is not used, however, when you determine the
gain or loss on the later disposition of the new car. See Publication 544,
Sales and Other Dispositions of Assets, for information on how to report
the disposition of your car.)
To figure the unadjusted basis of your new car for depreciation, first add
to your adjusted basis in the old car any additional amount you pay for the
new car. Then subtract from that total the excess, if any, of:
1. The total of the amounts that would have been allowable as depreciation
during the tax years before the trade if 100% of the use of the car had
been business and investment use, over
2. The total of the amounts actually allowable as depreciation during those
years.
Example 1. In March, Mark traded his 2002 van (placed in service in June
2002) for a new 2006 model. He used the old van 75% for business and he
used the new van 75% for business in 2006. Mark claimed actual expenses
(including $12,756 depreciation expense total) for his old van for 2002. He
did not claim a section 179 deduction for the old or the new van.
Mark paid $19,500 for the 2002 van in June 2002. He paid an additional
$12,500 when he acquired the 2006 van. Mark was allowed ˝ of the
depreciation deduction amount (which is included in the $12,756
depreciation expense total) for his old van for 2006, the year of
disposition, as explained later under Disposition of a Car. Mark does not
claim the special depreciation allowance.
Example 2. Rob paid $21,000 for a new car that he placed in service in
2003. He used it partly for business in 2003 (9,600 business miles of
15,000 total miles), 2004 (12,000 business miles of 16,000 total miles),
and 2005 (14,400 miles of 18,000 total miles). He used the standard mileage
rate in those years to claim the business use of his car. (See
“Depreciation adjustment when you used the standard mileage rate” under
Disposition of a Car, later.)
Modified Accelerated Cost Recovery System (MACRS). The Modified Accelerated
Cost Recovery System (MACRS) is the name given to the tax rules for getting
back (recovering) through depreciation deductions the cost of property used
in a trade or business or to produce income.
The maximum amount you can deduct is limited, depending on the year you
placed your car in service.
Recovery period. Under MACRS, cars are classified as 5-year property. You
actually depreciate the cost of a car, truck, or van over a period of 6
calendar years. This is because you car is generally treated as placed in
service in the middle of the year and you claim depreciation for one-half
of both the first year and the sixth year.
If you
dispose of a car, you may have a taxable gain or a deductible loss.
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