Eye on the World
Recently a 1936 Bugatti Type 57SC Atlantic sold for a reported $40 million. Granted, that’s the world’s most expensive car, and one of only three ever built, but the cost raises an important financial question for car aficionados. Classic car and race car collectors claim the reasons for their expensive purchases are varied but most often include personal pleasure and recreation, increasing asset value and short-term market movement, or business profit. While acquiring beautifully restored antique cars may be your high-octane passion, the IRS could see this hobby as a business, thereby changing your tax status.
In terms of tax issues, the distinction between collectors, investors and dealers is of great importance. A collector is considered someone who buys and sells vehicles for personal pleasure and/or recreation. An investor is seeking profit from appreciation of a vehicle’s value and a dealer’s purpose is to pursue business profit by selling vehicles to his or her customers.
Consider the effects of these tax advantages and disadvantages on your collecting status:
The tax rate on long-term collectible capital gain is 28%, whether you are a collector or an investor. A collector’s capital loss is disallowed and deduction of collecting expenses is limited.
Investors are allowed to deduct capital loss in the current year depending on their capital gains status and they face a tax rule that is generally more favorable than that which collectors face.
But becoming a vehicle dealer may create additional, unique tax advantages.
Because tremendous sales tax is imposed on valuable antique cars and racecars, more tax advantages may result from sales tax savings which a dealer is not required to pay if cars are purchased as inventory with intent to resell. Though your net income is subject to the ordinary income tax rate which is 7% higher than the collectible capital gain rate, your business-related expenses are completely deductible as part of ordinary trade.
When acquiring antique or classic cars, you have choices, each with pros and cons. Although the risk of an IRS Hobby Loss tax 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 profit, purpose and reasonable regularity and continuity of your trade or business. There are additional exceptions to tax rules for dealers of which a tax advisor can inform you. It is highly recommended you consult with an advisor for tax implications before any critical decisions are made.Read more...
Call it a business, and collecting offers a variety of tax deductions. Call it a hobby, and the IRS is likely to be much more restrictive. Their guideline is called “the hobby loss rule” and here’s why it matters
With uncertainty surrounding the U.S. dollar, many high-net worth individuals are purchasing rare and collectible items such as high-priced art, race cars and race horses to protect their wealth from market fluctuations.
What some collectors buy, sell and consider a business, the IRS may consider a hobby, impacting a person’s tax status.Â And it is the IRS, not the taxpayer, who makes the determination. A person’s only recourse is to appeal to the federal government.
Internal Revenue Code Section 183 (Activities Not Engaged in for Profit) limits deductions that can be claimed when an activity is not engaged in for profit. IRC 183 is sometimes referred to as the “hobby loss rule.”
The IRS reminds collectors to follow appropriate guidelines when determining whether their collecting will be considered a business or a hobby, which is defined as an activity not engaged in for profit.
In order to defend a business vs. a hobby, a person should consider the following factors:
- Does the time and effort you put into the hobby indicate an intention to make a profit?
- Do you depend on the income from the activity for day-to-day living?
- If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of becoming a collector?
- Have you changed methods of operation to improve profitability of a transaction?
- Do you or your advisors have the knowledge needed to carry on the activity as a successful business?
- Have you made a profit in similar activities in the past?
- Does the activity make a profit in some years and not other years?
- Can you expect to make a profit in the future from the appreciation of assets used in the activity?
The IRS presumes that an activity is carried on for profit if it makes a profit during at least three of the last five tax years, including the current yearÂ —Â at least two of the last seven years for activities that consist primarily of breeding, showing, training or racing horses.
If an activity is not for profit, losses from that activity may not be used to offset other income. An activity produces a loss when related expenses exceed income. The limit on not-for-profit losses applies to individuals, partnerships, estates, trusts, and S corporations. It does not apply to corporations other than S corporations.
Deductions for hobby activities are claimed as itemized deductions on Schedule A (Form 1040). These deductions must be taken in the following order and only to the extent stated in each of three categories:
- Deductions that a taxpayer may take for personal as well as business activities, such as home mortgage interest and taxes, may be taken in full.
- Deductions that don’t result in an adjustment to basis, such as advertising, insurance premiums and wages, may be taken next, to the extent gross income for the activity is more than the deductions from the first category.
- Business deductions that reduce the basis of property, such as depreciation and amortization, are taken last, but only to the extent gross income for the activity is more than the deductions taken in the first two categories.
For additional information, reference IRS article http://www.irs.gov/newsroom/article/0,,id=169490,00.html