Car Collections: Collectors, Investors, or Dealers Status
by Alan L. Olsen, CPA, MBA (Tax)
Greenstein, Rogoff, Olsen & Co.
Recently a 1936 Bugatti sold for over $30 million. Granted, that’s the world’s most expensive car, and one of only three ever built, but it raises an important financial question for car collectors.
While acquiring beautifully restored antique cars may be someone’s high-octane passion, the IRS could see that “hobby” as a business, thereby changing a person’s tax status.
As with many items within a wide range of expensive collectibles, those interested in classic cars and racecars often claim the reasons for their purchases are varied but most often include personal pleasure and recreation, increasing asset value and even short-term market movement, or business profit.
In terms of tax treatments, the distinction between collectors, investors and dealers is of great importance. Between collectors and investors, the tax rule is generally more favorable to the investors. Whereas, being a vehicle dealer may create unique tax advantages.
A collector is considered someone who buys and sells vehicles for personal pleasure and/or recreation. An investor is seeking profit from the appreciation of a vehicle’s value. A dealer is pursuing business profit by selling vehicles to his or her customers.
The tax rate on long-term (collection held for more than one year) collectible capital gain is 28%, whether you are a collector or investor. With regard to capital loss, investors are allowed to deduct the loss in the current year as long as they have enough capital gain to offset such loss. Otherwise, the loss in excess of $3,000 is carried forward to offset future years’ capital gains.
In contrast, a collector’s capital loss is disallowed. For both collectors and investors, the deduction of collecting expenses (e.g., appraisal fee, maintenance expense, etc.) is treated as miscellaneous itemized deductions, subject to the 2% AGI (adjusted gross income) limitation. Additionally, the unfavorable Hobby Rule may apply to collectors, thereby only allowing them to deduct the expenses to the extent of their hobby income.
With this in mind, consider establishing a vehicle dealership if you are doing substantial and frequent purchases and sales. The disadvantage is that your net income is subject to the ordinary income tax rate. The current highest rate is 35%, 7% higher than the collectible capital gain rate. However, more tax advantages may result from sales tax savings such as a full deduction of ordinary losses and escape from passive loss limitation.
Tremendous sales tax is imposed on valuable antique cars and racecars. A dealer is not required to pay sales tax on vehicle acquisition if they purchase the car as inventory with intent to resell. If the vehicle is sold at retail to an end-user, sale tax will apply. (You may need to be very careful about the more stringent use of the tax rule governed by the California Board of Equalization).
A vehicle dealership is considered ordinary trade or business. Its business-related expenses are completely deductible if they are ordinary, necessary and reasonable. Even if the expenses exceed the sale receipts, the excess is allowed to offset income from other activities, even investment activities (e.g., capital gains) or treated as a net operating loss (NOL) to carry back and forward.
Although the risk of an IRS “Hobby Loss” challenge is low, you may still need to pay attention, to not raise red flags. The key point is that you should keep adequate records to substantiate your “for-profit” purpose and reasonable regularity and continuity of your trade or business.
Furthermore, you should avoid the Passive Loss Rule kicking in which could suspend your loss deduction. This requires that you physically participate in the operation and management of your dealership business. As an alternative, properly using the Passive-Activity-Grouping Rule may help you escape the passive loss limitation for both a vehicle dealership and other business activities even though you are not a material participant. You will have a chance to apply exceptions to the passive rule to circumvent undesirable passive loss suspension.
When acquiring antique or classic cars, you have choices, each with pros and cons. It’s highly recommended you consult with a tax advisor for tax implications before any critical decisions are made.