Lemon law settlement taxable?

[Opus 17]

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@schmange21 wrote:

Hi, I have been told by someone who also had a lemon lawsuit that you can deduct the interest from the new car bought due to surrendering your other car. Is that true?

1099-MISC $74,000

original lemon car cost - $58,000

Interest on new car financed also a write off?

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Sorry.  Interest on personal loans is never tax deductible.  And whatever you did with the settlement (buy a new car, take a vacation, etc.) has nothing to do with the taxability of the settlement.

The settlement is taxable if it is more than the adjusted cost basis of the vehicle.  The adjusted cost basis is generally the price you paid.  You can include the sales tax, and you can include any legal fees that you would have had to pay even if you bought the car for cash (like a fee to register the car and get a license plate, a DMV safety inspection sticker, and so on.)  Fees associated with borrowing money to buy the car are not adjustments to the basis.

Other adjustments to the basis would be improvements that increase your property’s value or useful life, or that adapt it to new uses.  Paying for tinted glass, or accessibility conversion, or probably even under-car rust treatment, would count.  Unfortunately, repairs to restore the car to as--was condition are not adjustments to basis.

If you held the car more than one year, you can report this as a capital gains transaction, where you sold the car back to the manufacturer for the settlement amount.  Capital gains are taxed at a lower rate than ordinary income. 

[schmange21]

How do I show the capital gain with the 1099-Misc?

[Opus 17]

I would not report the 1099-MISC in the section for 1099-MISC.  Even if you make the adjustment (there is a trick for this) you will pay tax on the difference as ordinary income instead of at the lower capital gains rate.

Go to the section for "Sales of investments". Pick "other" for the type of sale.  Enter the information including the purchase date, sell date, selling price.  For purchase price, use your adjusted basis.  The IRS should not have a problem if they see the sales proceeds in the investment section instead of the misc section.  Maybe for description of item sold you could write "Lemon law settlement 2023 Tesla", it might help if they have questions.  Of course, save copies of your documents in case of audit.

[tamtrinh]

Hi, 

Thank you for sharing your case. 

Did you return your car to manufacturer? or you kept your car when you got $60,600? 

Please help me to understand 

Tam Trinh  

3/25/2024

[tamtrinh]

Question.  I won a lemon law settlement of 45,000 ( $28,500 actual damage + $16,500 additional damage ( $30,000 x 55%) . It was on the check, $45,000.  The attorney  firm got $13,500 ($30,000 x 45%).  I was able to KEEP the car.  I originally bought the car for 28,500.  What do I pay tax on? 

My case was I KEPT the car. 

Do I have to pay income tax on $45,000 or on $16,500 ? 

Thank you 

Please help me.

Thank you so much.

[Opus 17]

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@tamtrinh wrote:

Question.  I won a lemon law settlement of 45,000 ( $28,500 actual damage + $16,500 additional damage ( $30,000 x 55%) . It was on the check, $45,000.  The attorney  firm got $13,500 ($30,000 x 45%).  I was able to KEEP the car.  I originally bought the car for 28,500.  What do I pay tax on? 

My case was I KEPT the car. 

Do I have to pay income tax on $45,000 or on $16,500 ? 

Thank you 

Please help me.

Thank you so much.

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You treat this as the sale of your car under "sales of stock and other property."  Your purchase price was $28,500, your selling price was $45,000.  You pay capital gains tax on the difference ($16,500).  If the owned the care for more than a year before the settlement, your capital gains is taxed as a long term capital gain at the lower rate.

Now at this point, because you kept the car, your adjusted cost basis is zero.  That means that when you dispose of the car in the future, you may have another capital gain.  For example, suppose you sell the car as a used car in 5 years for $10,000.  You would normally consider that since you bought the car for $28,500 and sold it for $10,000, you have a loss.  Losses on personal property are not deductible but you would not owe tax either.  Here, if you sell as a used car for $10,000, you have a $10,000 gain because your adjusted cost basis is zero.  

[schmange21]

Hi, I did not keep the car I surrendered it.

[Opus 17]

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@schmange21 wrote:

How do I show the capital gain with the 1099-Misc?

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Don't enter the 1099-MISC in the section where it would normally go.  Instead, go to the section for "sale of stocks, investments and other property."  Choose "something else".  Treat the car as though you sold it for the price of the settlement.  When you enter the purchase price (cost basis) and date of purchase and date of sale, the portion that is a taxable gain will be calculated as either a long or short term gain.  Save the 1099 and your other documents for three years in case the IRS sends a letter to ask for clarification. 

[tamtrinh]

Thank you for helping me. 

In my case, I was able to keep my car. I received the check was $45,000, I paid the car was $28,500. Can I use the method $45,000 - $28,500 = $16,500, capital gain is $16,500 ?

Thank you so much. 

[tamtrinh]

Thank you so much. 

[Opus 17]

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@tamtrinh wrote:

Thank you for helping me. 

In my case, I was able to keep my car. I received the check was $45,000, I paid the car was $28,500. Can I use the method $45,000 - $28,500 = $16,500, capital gain is $16,500 ?

Thank you so much. 

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I already answered you above.  Yes, you can do the same calculation, but your car now has a cost basis of zero.  That means that if you receive any more money when the car is disposed of (including selling as a used car in the future, or wrecking it and getting a settlement), that will also be a capital gain. 

[schmange21]

Perhaps if you don't mind, can I got a bit further and explain a little more in detail what is going on? They split the settlement between my partner and I. Since we are not married they separated both of our 1099's so we each got a 1099 for $74,000 (so $148,000 total). We file separately since we are not married. We each will have one 1099 for our tax return. If we use the capital gain option, I assume I should split the cost of the car when we both purchased it to put on the line for the tax return? 

[Opus 17]

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@schmange21 wrote:

Perhaps if you don't mind, can I got a bit further and explain a little more in detail what is going on? They split the settlement between my partner and I. Since we are not married they separated both of our 1099's so we each got a 1099 for $74,000 (so $148,000 total). We file separately since we are not married. We each will have one 1099 for our tax return. If we use the capital gain option, I assume I should split the cost of the car when we both purchased it to put on the line for the tax return? 

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Were you co-owners of the car?  Either both on the title, or both on the loan, so that you both had what is called a constructive interest?  If you were co-owners, then you each sold half the car.  Each of you will report half the cost as your cost basis.  

[schmange21]

Yes, we both co-owned the car. Thank you!