By Howard Abrams, PBS Tax & Bookkeeping
One of the most perplexing problems we have is explaining to owner/operators the ramifications of selling equipment that has been partially or fully depreciated. Once understood, it is clear that the outright sale of equipment is actually tax favorable.
Q. I sold my equipment at a loss. I ended up with very little cash. How can I possibly owe income tax on the sale? How can I end up with a taxable gain? Something is wrong.
A. It sure seems that way. If I weren't a tax preparer, I would be asking the same questions. I would not understand nor accept the answer.
But as a tax preparer, I do understand and accept it and so I will try to explain it.
As we see from the chart of your sale of your tractor below, you paid $100,000 three years ago and sold it for $45,000. During those three years, you deducted depreciation in the amount of $70,000 on your income taxes.
|Sale of Tractor|
|Amount of sale||$ 45,000|
|Cost of the tractor||100,000|
|Less: Depreciation||- 70,000|
|Adjusted Cost (1)||= 30,000|
|Gain on Sale||$ 15,000|
(1) Adjusted cost is original purchase price less all depreciation taken up to the sale of the tractor.
In the example above, the $70,000 depreciation saved most taxpayers approximately $20,000 in income and self-employment tax.
Since you received tax benefit by deducting $70,000 in depreciation on your income tax return for those three years, the depreciation must now be deducted from the original purchase cost to arrive at the adjusted cost. That adjusted cost is what is subtracted from the sale price to determine the gain or loss for income tax purposes. That is the law.
When you include the $15,000 gain on your tax return, yes, you pay income tax on it, but not the self-employment tax. That is favorable to you.
Q. OK, I see, according to the law, that I have a gain. But I sold it for $45,000 and only have $15,000. I don't understand.
A. Since you borrowed $100,000 to buy the tractor and owed $30,000 when you sold it, you are left with $15,000 after the $30,000 is paid to the bank to pay off the loan, as shown in the chart below.
|Sale of your tractor,|
|per above||$ 45,000|
|Amount borrowed to buy the tractor||$100,000|
|Less: Amount paid on loan||- 70,000|
|Balance due on loan (payoff)||30,000|
|Cash that you have||$ 15,000|
Q. What if I had paid cash for the tractor?
A. If you had paid $100,000 cash for the tractor instead of borrowing the money, you would have $45,000. Therefore, the purchase and subsequent sale would have cost you $55,000 out of your pocket.
|Example of purchasing tractor for cash:|
|Cash out of pocket to purchase tractor||$100,000|
|Less: Cash realized on sale||- 45,000|
|Net cash out of pocket||$ 55,000|
When you compare that to the amount of cash out of pocket if you had borrowed the $100,000 to purchase the tractor, you would be out the same amount of cash from the transaction.
|Example of borrowing $100,000 to buy tractor:|
|Cash out of pocket to purchase tractor||- 0 -|
|Cash paid out during life of asset for the loan||$ 70,000|
|Less: Cash to you upon sale – per above||- 15,000|
|Net cash out of pocket||$ 55,000|
Everyone's financial situation is different. This article does not give and is not intended to give specific accounting and/or tax advice. Please consult with your own tax professional.
This article is written by PBS Tax & Bookkeeping Service, a company that has been providing income tax and bookkeeping services to the trucking industry for more than a quarter-century. If you would like further information, please contact PBS at 800-697-5153 or visit their website at www.pbstax.com.