What is the cost basis in a leased car that was sold for a gain, but which I never had possession of?

[Razorback2424]

Fact Pattern:

- Sold a car in August 2021, which had been leased for 36 months, and received a check for $8,000

- It was "sold" to a third party, who paid the lessor directly, to where I personally never took title of the car.

- Total of lease payments was $12,600

- Residual was $22k and was offered $30k for the car

What would be my taxable gain on the $8,000 (if any) and would it be short-term or long-term capital gain? 

[DoninGA]

There is no cost basis since you were not the owner of the vehicle.

Assuming the leased vehicle was for personal use only and Not used in a business you could not deduct the lease payments as an expense on a tax return.  If you received any funds from the owner (lessor) then that would be a refund of your lease payments and are not reported as income on a tax return.

Other opinions?  @Critter-3  @rjs 

[Mike9241]

i would say you probably have no taxable income.  the residual value at the start of the lease was estimated to be $22K which directly affected the monthly lease payments. had the residual of $30K been used your lease payments would have been lower. so unless you took a business deduction for the lease payments the $8K should be tax-free. 

[rjs]

First, let me emphasize something that DoninGA said. We are assuming that the car was only for personal use, and there was no business use. If that assumption is not correct, just ignore everything that's been said here and start over with more information about how the car was used.

You might need a lawyer to sort this out. It's not clear what really happened. But here are my thoughts. (And I am not a lawyer.)

I assume that the lease gave you the option to buy the car at the end of the lease for $22,000. The third party was not a party to the lease, so he had no particular claim to the car, and the leasing company had no particular obligation to allow him to buy the car.

IF it's true that you never took title to the car, then you must not have exercised your option to buy the car. You returned the car to the leasing company at the end of the lease, and they sold it to the third party. (If you did exercise the option to buy the car, then you did own it, even if only for a few minutes, and even if your ownership was not registered with the DMV.) If you never owned the car, then you never sold anything, so you do not have any kind of capital gain. But somehow you ended up with $8,000. So the question is, what is the nature of that $8,000 that you acquired?

There are two questions that you have not given the answers to.

1. Did the lease have a provision giving you some kind of refund or rebate if the leasing company sold the car for more than the residual value that was estimated when the lease was signed?

2. You said that the third party paid the leasing company directly, but you didn't say how much he paid them. Did the third party pay $30,000 to the leasing company, and the leasing company then paid you $8,000? Or did the third party pay $22,000 to the leasing company and $8,000 to you?

If the third party paid $30,000 to the leasing company, and the leasing company then paid you $8,000, then the $8,000 might indeed be considered a refund of part of your lease payments, which, as DoninGA said, would not be taxable income. If the payment of the $8,000 was required by a provision in the lease, that would add strength to this argument.

But if the third party paid the $8,000 directly to you, then it would appear to be payment for some sort of service that you provided in facilitating his purchase of the car. In that case, it would be ordinary income to you, and it would be fully taxable. Again, it's ordinary income, not capital gain, because you didn't sell any asset.

I suggest that you consult a good tax lawyer.

[AmeliesUncle]

These are generally for commercial vehicles, but was it a TRAC lease?

Or was there any part of the contract that said you purchased the vehicle at the end of the lease (for $22,000), and they sold it for you?

[Razorback2424]

I appreciate the overwhelming response and the insight!

I did leave that critical factor out, as it does get a little more complicated bringing in the business v. personal discussion. We used the standard mileage method of deducting approximately 75% of the miles driven on the car, with the other 25% being personal. I don't know if there's any depreciation recapture involved with that situation. 

- No provision for refund or rebate in the lease. 

- You are correct that it gave ME the option to purchase the vehicle for the residual, not the third party.

- The third party paid me directly the $8,000. They paid the lessor the $22k residual and got title to the car.

Is there any logic to the argument that the lease payments were, in essence, option payments for the RIGHT to purchase the car at a set price (the residual) along with the ability to drive it for a set amount of time. I could exercise the right to purchase at any point in the lease, but didn't exercise it. Instead, I opted to sell that right to the third party lease broker, who then exercised that right after it was sold to him. The lease payments are greater than the payment received, but not sure about depreciation recapture or whether I need to bifurcate how much of the lease payments was for the right to drive and how much was for the right to purchase. Gets very complicated very fast.. 

[NCperson]

food for thought - 

the lease payments were predicated on a presumed residual.  Had the lessor known the car would be worth a lot more at the end of the lease, they would not have had to charge as much in lease payments.  

why isn't 75% of the $8,000 taxable income as the lease payments would have been resulted in $6,000 less in expenses over time had the residual been known at the beginning of the lease?  The $6,000 just claws back what had been expensed over time

The last $2000 just reduced the personal expense that occuted over time. Neither the expense or this one time payment of $2000 was taxable expense or income, so no inpact on the tax return.

Again, just a thought... is it this simple? 

[rjs]

@Razorback2424 

Focus on the basics. You did not sell the car, because you never owned the car. Since you never owned the car, basis and depreciation are irrelevant.

The broker paid you $8,000, essentially for your services in facilitating his purchase of the car. That's $8,000 of ordinary income to you. You have to pay tax on the entire $8,000 at ordinary income rates. It is not capital gain. You probably have to treat $6,000 (75%) of the payment as business income. You didn't say what kind of business organization you have. If it's a sole proprietorship (Schedule C), treating it as business income means you will have to pay self-employment tax on the additional $6,000 of business income, in addition to the regular income tax.

I doubt that the lease actually said that you could sell the right to purchase the car. That argument is a big stretch. You didn't sell anything. You just made a deal that paid you $8,000. It's fully taxable ordinary income, and 75% of it is attributable to your business.

I think NCperson's argument based on what "would have been" is too convoluted, and I don't agree with his conclusion that the $2,000 is not taxable. You could claim that any income you earn is a reduction of some personal expense. That doesn't mean that the income is not taxable. The $2,000 (or the $8,000) is not a refund of part of your lease payments. It's new income.

[selsheikh]

Hi,

But if the payments were a refund or rebate for lease payments paid that were deducted on Income statement then it would still be income since you took a deduction in previous months or years.  It would be ordinary income since you didn't own the vehicle.  I am mainly referring to a business vehicle not personal purposes and maybe that is the disconnect.

Shariff