It’s the end of a great year for the collector car market. As it winds down, readers should take the opportunity to focus on a number of planning details.
Tax rates likely to stay the same
Year-end tax planning doesn’t look terribly complicated this year. Election season is in full swing — even though the election is many months away — and neither party seems very interested in starting a battle over tax rates. Consequently, it seems safe to predict that 2016 tax rates will stay the same as 2015 rates. That means there is no rush to sell a car before the end of the year.
Deducting state income taxes
We don’t get many itemized deductions any more, but one of the major ones is state income taxes. Keep in mind that they are deductible in the year paid, not the year they relate to. If you made a substantial taxable sale in 2015, consider paying your state income taxes before December 31 to deduct them on your 2015 federal return.
But before you write that big check, talk to your accountant. The phase-out of itemized deductions and the alternative minimum tax can limit your deductions or even make them worthless.
The rules and their application to your situation are extremely complex, and it’s near impossible to generalize. Your accountant has to run the numbers and determine how much of a deduction you can actually benefit from this year. That is the magic amount you should pay to your state — if you pay more, the deduction is worthless, so you might as well pay it next year and maybe it can benefit you then.
Capital gains rate in court
“Legal Files” has explained many times that, despite nagging uncertainty about the law, gains on the sale of collector cars are taxed at the 20% rate, not the 28% rate applicable to “collectibles.” This issue recently landed in the U.S. Tax Court, and it may soon be resolved one way or the other.
In this case, a California tech company executive sold 11 cars during 2011 at a gain of about $30 million. The cars included seven Ferraris, two Porsches, a Mercedes-Benz and a BMW. The Internal Revenue Service insisted that the cars were “collectibles” subject to the 28% rate. The taxpayer appealed the audit results to the Tax Court in late August. A decision is probably at least a year away.
While “Legal Files” is betting that the taxpayer will win, most anything can happen in court. Also, it is possible that the case will be settled before trial, which will give the rest of us no guidance whatsoever.
If you sold a collector car at a gain in 2015, it still makes sense to pay the 20% rate. However, since this Tax Court case is presently pending, it also makes good sense to hedge your bets and get a formal legal opinion about the applicable tax rate. The opinion won’t guarantee you the 20% rate, but if it turns out that the 28% rate applies, you should be protected from tax penalties on the basis that you relied on legal counsel in reporting the way that you did.
The trick is that you have to have the legal opinion in hand when you file your return. Since April 15 will come quickly, it’s best to get working on that opinion right away. You can’t file the return and get the opinion later.
Unused 2015 gift exclusions
Shifting to gift and estate taxes, one of the best planning techniques available to us is the annual gift tax exclusion. You can make a gift of up to $14,000 each year — and it doesn’t even count as a gift. While that isn’t a huge amount, it can add up in a family situation – a married couple with three children can gift $84,000 to their children each year.
There have been two favorable recent court cases dealing with gifts of partial ownership interests in art works that open the door to significant valuation discounts. Say you and your spouse gift a 25% interest in your $500,000 Porsche Speedster to your three children. While that carries an economic value of $125,000, an approximately 33% valuation discount will bring the gift tax value down to the $84,000 available exclusion.
The secondary effect is that your retained 75% interest is also a partial interest that can be valued at a discount for estate tax purposes. At the same 33% discount rate, that reduces your estate tax value to $251,250. Add it all up, and the $500,000 Speedster ends up with an aggregate gift and estate tax value for the family of $335,000, which should save you somewhere around $80,000 in estate taxes.
There are other estate-planning techniques that can be used to plan for your car collection which can yield more dramatic savings. However, the 2015 annual gift tax exclusions will disappear if they aren’t used before the end of the year, so they might be a piece of the solution that should not be ignored.
It seems that many of us see winter as the right time to get our cars worked on, as we probably aren’t going to be driving them all that much. But before taking advantage of that “perfect” time to get that restoration started, consider that restorations continue to be one of the prime areas of litigation in the collector car hobby.
Here is the classic story that keeps repeating: Collector takes his collector car to a restoration shop for that long-awaited restoration. The shop owner advises the work will take X months and cost around $Y. The shop invoices monthly and is paid as the invoices are issued. Eventually, the unhappy owner confronts the shop. “It’s been X + 12 months, I’ve paid you $Y + $50,000, my car is still in pieces, and there is no end in sight.” The shop owner replies, “It’s been harder than I expected, and X and Y were just non-binding estimates.” Pretty quickly, it becomes a Legal File.
Once you get to that point, it’s hard to see a happy ending. The solution is to start the project with a good contract to help avoid surprises. It isn’t easy to agree on a fixed-price contract in most cases, since the scope of restoration work is usually hard to predict until you get into it. But you can divide the project into smaller steps, with appropriately designed checkpoints and specifics about how the work within each segment is going to be charged.
Writing a comprehensive restoration contract takes time and attention — and the assistance of legal counsel who knows how these projects play out. But it’s well worth the cost and effort.
Many collectors let their guard down this time of year. Their cars don’t get driven much, so insurance claims don’t seem very likely.
That can turn out to be a huge mistake. A semi isn’t going to flatten your garaged collector car, but your car is still at risk. Just imagine a fire or a flood. Consider that it takes a pretty big crash to total your collector car, but a fairly small fire or flood can total it quite easily.
You also expose your car to risk if it is being transported to a repair shop or an auction for sale.
Since most collectors use agreed-value policies, it’s critical to be sure that your agreed value reflects today’s market. It’s been a hot one lately. For example, most every air-cooled Porsche in existence has doubled in value in the past year or two. Ditto for Ferrari 308s and 328s, and many other cars. If your car gets totaled, your insurance company pays you the agreed value and they own the remains. Think of it as a forced sale at a fraction of the value of your car.
Take the time to contact your insurance company and review the adequacy of your agreed values. Don’t put it off to spring when it’s time to start driving again.
Arizona auctions coming up
If you are going to be selling a car in Arizona and plan to defer the tax with a 1031 exchange, get your exchange accommodator lined up now, so you know the procedures and requirements. Also, let the auction company know now, so they can get things set up at their end for a seamless transaction.
Recognize that time will become your enemy and start looking for your replacement car(s) now. Once your car sells, you have only 45 days to identify your replacement car(s). That time can fly by.
You can increase your search time by starting now. If you can find a suitable replacement car now, you might be able to tie it up with a nonrefundable deposit, with the actual purchase delayed until after the auction sale. That beats scrambling around on the 44th day looking for the perfect car to buy. ♦
John Draneas is an attorney in Oregon. His comments are general in nature and are not intended to substitute for consultation with an attorney. He can be reached through www.draneaslaw.com.