Selling an Asset? Here's How to Calculate Your Donation to Uncle Sam. The important term you'll have to deal with here is 'book value.'
By Doug and Polly White Edited by Dan Bova
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We have a client who owns a limousine business. Recently, someone offered to buy one of her older cars -- obviously used for business -- for about $10,000 more than its Blue Book value. She was inclined to accept the offer, she later told us, but was worried that she would owe a great deal of taxes because the sale would be so profitable.
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She contacted us to ask if there was a way she could estimate her tax burden if she did sell the car.
If you're like this woman, with an asset to sell, you too might like to understand how a sale affects your taxes. So, to take the example of the car, we explained to our client that tax she'd pay would have nothing to do with its Blue Book value.
We can understand why she might believe that if she made money beyond her asset's official value -- or lost it for selling the asset for less than that value -- her tax bill would mirror that event.
And, in fact, her business would pay taxes on the profit made from the sale; but that profit wouldn't be calculated on the car's Blue Book value, but rather the company's book value of the car. That profit is calculated this way:
The profit = the amount for which the car is sold – the book value of the car.
Meanwhile: The book value of the car = the amount you paid for the car – the acccumulated depreciation on the car.
Therefore: Your profit = the amount for which you sell the car – (the amount you paid for the car – the accumulated depreciation).
Here are some more simple examples. Suppose you bought a car for $75,000 and sold it the same day, for $80,000. You would pay taxes on the profit of $5,000 ($80,000 - $75,000). There would be no depreciation because you sold the car before you claimed any depreciation.
Let's say your tax rate is 40 percent (to keep the math simple). Your tax on this transaction would therefore be $2,000, or 40 percent of $5,000.
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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 realize a $5,000 loss, which would reduce the taxes you would pay on the other profits of the business.
Now, let's add depreciation back into the mix, 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 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) was reduced by the cumulative depreciation.
Accordingly: The book value of the car was $50,000, which is $75,000 – $25,000.
If you sold the car for $80,000, your profit on the transaction would be $30,000, or $80,000 – ($75,000 – $25,000), or $80,000 – $50,000.
Therefore, if your tax rate was 40 percent, you would pay taxes of $12,000, or 40 percent 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 realize a loss and create a tax reduction.
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In summary, you can estimate the taxes you'll have to pay on the sale of the car (or any asset) by subtracting the book value of the asset from the price you are paid and multiplying the difference by your estimated tax rate.
