I was at a luxury car dealer and they clearly gave me a low-ball offer on my trade. When I told them that I would rather sell it privately, they said “Well, if you do that you will have to pay thousands of dollars in income tax.” This sounds fishy to me, can the IRS tax you on a private sale?

So the short answer is this dealership clearly has no idea how the tax code works. Now I am no CPA, but I spoke to a tax accountant and this is what he said:

Usually when people purchase a car it is considered a depreciating asset. Most people buy a new or used car and it loses value over time; when you sell it you are selling it at a loss. If you purchase something and sell it for less than you bought, that sale is not considered taxable income because you didn’t make any profit...

There you have it. If a dealership is trying to convince you that their low-ball trade offer is great because the IRS will be on your back if you sell your ride on Craigslist, you may want to go elsewhere. Of course there may be a tax benefit to trading your car instead of selling it, but it depends on the state and it would only reduce sales tax on the new car you are buying.

While we are on the topic of car sales and taxes my CPA friend did say the following:

...Of course if you do make money off your car, in the way of buying somethiing cheap, fixing it up, and then selling it for more than the price of the car plus the parts, that would be considered profit and therefore taxable income. Or say you bought a collectable car and stuck it in the garage for awhile and sold it for more than the MSRP, again the IRS will want a piece of the action there.

So if you are doing something , and buy an old Mercedes beater for $2,000, put all kinds of hard work and $1,000 worth parts in it, then sell it for $6,000, you made $3,000 profit on that sale. That income is technically taxable. It’s a good thing Tavarish keeps careful records of his expenses. Or maybe you find a Chevy SS with a manual with the hopes that it will be a collector’s item someday. Ten years pass and three-pedal SS cars are going for eighty-grand on the auction circuit. You better be prepared to share some of that profit with Uncle Sam.

The point is if you lost money you are in the clear, but if you made money I don’t need to remind you that the IRS is the one government organization you don’t want to mess with. Al Capone was arguably one of the greatest gangsters in American history. The Feds couldn't take him down with murder, racketeering, or extortion...but they got him on taxes. So go ahead and flip those cars, just keep your receipts.

(H/T to Thomas G)