Many car dealerships offer their customers and clients the option to trade-in a used car and truck prior to the purchase or lease of a new vehicle. The reasons why dealerships offer this service are multi-faceted, but generally they can be summed up under two general assumptions. First, it is often profitable to purchase, repair, and sell used cars and trucks. Second, at least some customers would not buy or lease a new vehicle without the trade-in aspect of the deal. While accepting trade-ins is often profitable and can extend the market for a dealership, care must be taken to ensure tax compliance.
When an auto dealership purchases a used car or truck, it typically does so because it believes that it can resell the vehicle. At a minimum, the dealership may believe that it can receive compensation for the parts and vehicle scrap. However, when a person or entity purchases, obtains, or otherwise acquires property, the capital gain must be accounted for. At a minimum, the dealership must record the price at which the vehicle was purchased and the price at which it was sold or otherwise disposed of. The tax must be paid on the increase in basis on the property.
While the above sets forth very basic record-keeping requirements, the valuation of the vehicle must be based on some reasonable interpretation. The IRS auditor is likely to inquire regarding appraisal methods. While some dealerships may rely on valuation guides, others may cite to personal experience and historical data. However, Revenue Ruling 67-107, 1967-1 C.B. 115, states that used cars taken in trade as part payment on the sales of cars by a car dealer may be valued, for inventory purposes, at prices similar to those set forth in an official used car guide. Generally speaking, valuation of dealership inventory must accurately reflect the dealership’s primary market. Thus it would be improper for a dealership that primarily sells vehicles at retail to value their vehicles as if they were being sold at auction.