Understanding Taxes When Buying and Selling a Car

by Tim O'Sullivan

Updated on: July 21, 2021

When it comes to buying and selling a car, cutting out the middleman has plenty of perks. Buying a car from a private seller will usually result in a lower price tag. Selling one yourself will net you more money than what you’d get for a trade-in—but buying or selling from a dealership also has its conveniences, such as getting help in figuring out any necessary tax payments.

The laws on taxes for private party used-car sales vary by situation and by state, and in some cases, even by city. It may seem hard to understand, but it's not an insurmountable task.

Do I Have to Pay Tax When I Sell My Car?

If, like most people, you are trying to sell your used car for less than you spent on it, then you will not have to pay sales tax. The Internal Revenue Service (IRS) considers all personal vehicles to be capital assets. Selling that vehicle for less than your purchase price is considered a capital loss, which does not need to be reported on tax returns.

So, if you bought your car new for $20,000, drove it for 10 years, and are now trying to sell it for $7,000, the transaction should be straightforward, especially if you do it online with CarGurus. But if you bought an older vehicle for cheap, made improvements, and are selling it for more than you originally paid, you will have to report that when you file your federal and state income taxes, and you may find you owe.

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Selling a vehicle for a profit is considered a capital gain by the IRS, so it does need to be reported on your tax return. But figuring the dollar-amount of that gain is not as simple as comparing your purchase price to your sale price.

You’ll need to add the cost of the improvements you made to the car to your original purchase price (listed on the bill of sale you received when you first bought the car). An improvement is anything that's long-term, like new paint, a new sound system, or upgraded mechanical components. It does not include regular maintenance costs like oil changes or brake replacements. Again, paperwork is important—it's best to have receipts detailing the cost of each improvement to help you remember exact figures and to use as proof if needed. Keeping track of the details makes it easier to check your figures with an online tax calculator, too.

If you spend $7,000 on a car and an additional $1,000 on improvements but you sell the car for $7,000, it's considered a capital loss, and you don't need to pay tax on the sale. But if the original sales price plus the improvements add up to $8,000 and you sell the car for $10,000, you'll have to pay capital gains tax on your $2,000 profit.

Do I Have to Pay Tax When I Buy My Car?

Yes, you must pay vehicle sales tax when you buy a used car if you live in a state that has sales tax. However, you do not pay that tax to the car dealer or individual selling the car. You will pay it to your state's DMV when you register the vehicle.

The state where you pay vehicle registration fees is the one that charges the sales tax, not the state where you made the vehicle purchase. So, if you live in Massachusetts (a state that has sales tax) but buy a car in New Hampshire (a state with no sales tax), you will still have to pay tax to your home state of Massachusetts when you go to get your license plates. Traveling out of state to buy a used vehicle will not save you from paying state sales tax. Conversely, if you live in a no-sales-tax state (Delaware, Montana, New Hampshire, Oregon, and some parts of Alaska), you don’t need to worry about having to pay another state's sales tax rate if you choose to travel out-of-state for your next car purchase. Many states also allow local governments to charge local taxes. If you buy a new vehicle in New York, for example, the total amount of car sales tax you will pay varies depending on the city or county.

However, there are exceptions to the rule. Some states offer exemptions for out-of-state buyers as well as for family transfers, gifts, and other special situations. Contact your local Department of Motor Vehicles to find out the tax laws in your state. If you don't know which office to use or how to contact it, you can use the DMV.org office finder.

The Bottom Line

Trading your car in at a dealership has its benefits—including a nice tax break—but selling privately can earn you more money up front. However, if you're selling a car, it's a good idea to add up all the improvement costs and determine the total value of your car—if you sell it for any more than that number, you’ll be liable for capital gains tax.

Additionally, most shoppers need to stick to a budget when looking for a new car, so understanding your tax situation is important when deciding whether or not to sell your car privately.

Related Topics

How To Sell a Car You Haven't Paid Off Yet
How To Pick the Right Price When Selling Your Car
How To Make the Most Money Selling a Vehicle Privately

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