I think it has been established if you buy a car and it has appreciated in value, when the car is sold or traded-in for a net profit, capital gains tax is owed.
I think it has also been established if you lease a car, buy-out the car, and in-turn sell the car for a net profit (where sale > buyout), capital gains tax is also owed.
So what happens when you trade-in a lease (car A) that has positive equity, as part of a deal to buy a different car (car B)? In other words, the dealer is willing to pay more than the buyout amount for the lease. Thus you have a net profit, that is subtracted from the cost of car B.
I could see one reasoning capital gains tax is owed on the net profit from the lease trade-in (where dealer buyout > lease buyout). Since technically the lease trade-in is a different transaction than the purchase of car B.
On the other hand, the customer (lessee) never owned the lease car A (i.e. did not hold title). The bank (lessor) owned the lease. Thus how could the lessee make a sale and profit from a car they never owned? Also overall, there was not a profit; actually a "loss" from the purchase of car B.
Finally, the basis tracking of car B starts to get ambiguous. I assume the basis of car B is not the actual total that they paid, but rather the amount before the net trade-in was deducted?
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this is from a two-year-old thread but modified for your situation
we don't know the terms of the lease.
this is from an IRS website
You must first determine whether your agreement is a lease or a conditional sales contract. If the agreement is a lease, you may deduct the payments as rent (if for business otherwise not-deductible if personal). If the agreement is a conditional sales contract, you consider yourself as the outright purchaser of the equipment. You may generally recover the cost of such property used in a trade or business through depreciation deductions. No deduction if personal use.
Whether the agreement is a lease or a conditional sales contract depends on the intent of the parties as evidenced by their agreement, which is read in light of the facts and circumstances when it was entered into. Determine the parties' intent based on the facts and circumstances that exist when you enter into the agreement. No single test, or special combination of tests, always applies.
However, in general, you may consider an agreement as a conditional sales contract rather than a lease if one or more of the following conditions apply:
The agreement designates part of each payment towards an equity interest that you'll receive in the property.
You get title to the property upon the payment of a stated amount of "rental" payments required under the agreement.
The amount you must pay to use the property for a short time is an inordinately large part of the amount you would pay to get title to the property.
You pay much more than the current fair rental value for the property.
You have an option to buy the property at a nominal price compared to the value of the property when you may exercise the option. Determine this value when you enter into the agreement.
You have an option to buy the property for a small amount compared to the total amount you have to pay under the agreement.
The agreement designates some part of the payments as interest, or parts of the payments are easy to recognize as interest.
if you had a lease none of the payments add to your tax basis. your tax basis would be what you bought the vehicle for at the end (what you would pay according to the lease to buy the vehicle). if it was a conditional sales contract only the principal portion of the payments would be part of your tax basis also include any cap cost reduction you paid at the start and the buyout amount. the total would be reduced by any depreciation taken for business purposes to arrive at your tax basis. selling at a gain you would first need to recapture the depreciation, if any, as ordinary income and excess gain would be capital gain.
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if a lease, you are not selling the vehicle. you're selling your interest in the lease.
the next question for a lease is capital gain or ordinary income.
IRC 1221 defines what is a capital asset by listing what is not. leases are not excluded.
It is unclear as to whether you use the lease term for determining long or short-term capital gain.
If you bought the vehicle and then sold it there is no question that you would measure the holding period by using the dates bought and sold.
My opinion without anything to back it up would be if the lease term was more than a year you have long-term gain.
Thank you for the detailed reply @Mike9241
Yes I wondered regarding "whether you use the lease term for determining long or short-term capital gain." The trade-in transaction (buyout lease + dealer offer) is instantaneously on paper, but the lease term was 3 years. Thank you for the opinion.
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