Sale of car used in business (1099 employee) - how would it impact my taxes?

[Badjiannr]

Hi,

I am a 1099 employee and I bought a car in 2021. 

I deduct the depreciation of the vehicle as an expense. 

If I sell this car in 2023 and buy a new one, how would it impact my taxes?

Would I have a sort of a penalty on the depreciation taken?

Thanks

[VincentL]

Generally, since 1099 workers (freelancers and independent contractors) don't receive wages, they must pay their own payroll taxes. Those who are self-employed or sole proprietorships must pay the entire payroll tax on their own.

“Depreciation recapture” refers to the Internal Revenue Service’s (IRS) policy that an individual cannot claim a depreciation deduction for an asset (thereby reducing their income tax) and then sell it for a profit without “repaying the IRS” through income tax on that profit. By reporting the profit as ordinary income rather than as capital gains, which is taxed at a lower rate, the difference between the sale price and adjusted cost basis is “recaptured.”

In other words, any gain up to the amount of the depreciation which has been expensed will be taxed at ordinary income rates and not at the capital gains rate.

For example:

Car purchased for $20000

Depreciation of $5000

Adjusted basis is $15000

Sold for $17000

The $2000 above the adjusted basis is taxed at ordinary income tax rates and not at the capital gains rate.

There would not be a penalty. You would only pay the higher rate though.

[DanielleCPA]

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[Tax Hero Niki]

Hi Badjiannr!

Excellent way to think ahead!

If you sell a car just two years after it is placed in service, then yes, there may be a "sort of penalty on the depreciation taken". This would be known as depreciation recapture, and it comes into play typically if you elected to accelerate your depreciation through Section 179 or Special Bonus depreciation elections. There are a few factors involved in the calculation, and you can use TurboTax to run the scenario to get a feel for the impact.