Selling your classic car without selling out to the IRS

You’ve just sold your classic car and you’re ecstatic because the check you received was for a nice amount more than you paid when you bought the car. But how much of that profit can you keep?

“If you sell a car and make money, you’re supposed to pay taxes on it,” said John Draneas, an attorney and car collector who writes about the legal issues of classic cars for Sports Car Market magazine. Draneas made the keynote presentation at the magazine’s inaugural Scottsdale Insider’s Seminar held at the Gooding & Company auction venue.

“The Taxman and Your Collector Cars — How Do You Keep Them Apart?” was the subject of Draneas’ address to an audience that overflowed the seating area.

Draneas told the audience that the Internal Revenue Service “likes to make a splash” with its investigations. He explained that wealthy car collectors who don’t pay full and proper taxes are just the sort of people whom the IRS targets to show as examples.

But what are the proper taxes on the sale of your classic car?

“Keep really good, detailed records,” Draneas advised, explaining that if you have owned a classic car for a year or longer, your profit is considered a long-term capital gain and is taxed at a lower rate than if you owned the car for less than a year.

How much lower? Twenty percent versus 39.6 percent. Oh, and that’s by the federal government; state taxes also apply.

The amount of taxable profit is based not simply on the difference in the money you paid for the car and the money you received when you sold it. You can subtract any selling expenses and any restoration costs (provided, of course, you have kept those good, detailed records).

But what about the 28-percent federal tax on “collectibles”? Don’t worry, Draneas said, because federal tax law does not include cars within the definition of collectibles (which he said is a fact that escapes the notice of some accountants).

OK, so you sell a classic you’ve owned more than a year and you pay 20 percent in federal taxes on the profit. That’s it, right? Not quite. There is a new net investment income tax of 3.8 percent on anyone making $200,000 or more per year. Plus, there is the matter of state income taxes.

Or, Draneas said, you can take advantage of the 1031 lifetime exchange to defer your tax.

How does a 1031 exchange work? Either before the hammer falls at an auction or before you receive your check from a private sale, you transfer ownership of your vehicle to an “accommodator,” who sells the car and holds the money. You then have as many as 45 days to find a car or cars you want to buy with that money.

The accommodator actually makes that transaction as well, using the money from the sale of your car. You don’t see any of the cash but you do get your new car and you pay no tax.

If the car you want to buy costs more than the car you sold, you can add your own cash to complete the transaction.

Whew! Well, not quite, because there are sales taxes to consider. For example, buy a car at an auction in Arizona and drive it away, and you must pay Arizona sales tax. But have that same car shipped to your home outside Arizona and you don’t pay Arizona sales tax, though you will have to pay the sales tax in your home state.

Unless that home state is Oregon, where there is no sales tax. Draneas said that to encourage people to buy vacation homes in Oregon, state law allows the registration of any vehicle. The owner of that vehicle doesn’t have to reside in Oregon, but the car does.

The thought is that you leave a car at your vacation home to use while you’re in Oregon on vacation. The law allows you to drive the car anywhere you want, but it also requires that you bring it back to Oregon when it is not in use.

Or course, he said, driving that car outside Oregon, especially within your state of residence, likely means you are violating the law in your home state, which may require residents to register their cars where they actually live.

There is another alternative, he said, which explains why you see Montana license plates on so many classic cars. Montana will register any vehicle owned by an LLC established in Montana, where many counties have no sales taxes.

Draneas said some people think obtaining a car dealer’s license also allows them to avoid sales taxes, but for collectors, that would mean lying to their states, and it can making insuring the cars very difficult. It also eliminates the capital gains tax break or allowing a 1031 exchange.

After Draneas’ keynote, a panel of  Sports Car Market staffers — (from left) Keith Martin, Simone Kidston, Carl Bomstead, Donald Osborne and Steve Serio — discussed classic cars as blue-chip investments, and then led audience members on guided tours of vehicles available at the Gooding & Company auction, each panelist focusing on his area of expertise, from American sports and muscle to Ferraris and late-model European exotics.