Whether you have to pay taxes on the sale of your car mainly depends on how much you sell it for. If you sell a used car for less than its original purchase price plus any long-term improvements, the buyer may have to pay sales tax on the purchase, but you won't incur a tax obligation.
However, the scenario is different when you profit from the sale. If this happens, you'll pay short-term capital gains tax at your regular income tax rate on a car you owned for one year or less. If you owned the car longer than a year, you'll pay long-term capital gains tax. According to the Internal Revenue Service, the tax rate, which is based on the net capital gain, is usually no higher than 15 percent.
When You Won’t Owe Any Taxes
According to Edmunds.com, by the time you've owned a new car for five years, it's usually lost about 60 percent of its sticker value. Even if you installed audio equipment and a fancy security system, it's unlikely that these upgrades will increase the price substantially. This means there is usually very little chance a casual seller will profit from the sale of a car and have to pay a capital gains tax on it.
When You Might Incur a Tax Bill
Selling a collectible car may create a situation in which you incur a capital gains tax liability. However, this requires that the selling price exceed both the price you originally paid for the vehicle as well any restoration costs. For example, if you paid $800 for a 1957 Chevrolet in need of a complete restoration, spent $20,000 on the upgrades and then sold it for $35,000, you would owe capital gains tax on a profit of $14,200.
You might also have to pay capital gains tax if you sell a car received either as a gift or through an inheritance. However, for capital gains tax to apply in either situation, you'd have to sell the vehicle for more than its fair market value as of the day you took legal possession. For example, if your parents gave you a car for which they originally paid $15,000, but was only worth $8,000 on the day they transferred the title, you'd have to sell it for more than $8,000 -- assuming you made no long-term improvements -- to incur a tax liability.
You might need a dealer license if you regularly buy, fix and then sell vehicles. While licensing laws vary between states, many require anyone who buys and then sells more than five or six cars within a 12-month period to have a dealership license. If this applies to your situation, review motor vehicle laws for your state carefully, as this will likely affect much more than just your tax liability.