To paraphrase Benjamin Franklin, the only two certainties in life are death and taxes. Fortunately, you don't need to worry about the former when you're selling your car but you might encounter the latter.
Do I Pay Sales Tax When I Sell My Car?
If you profit from the sale of a car, you will need to pay capital gains tax.
It's generally not an issue for car sellers, as both new and used cars depreciate rapidly. But if you got a great deal on a vehicle or you spent a lot of time repairing and upgrading it before selling for a profit, you'll need to consider capital gains tax.
The good news is that you don't need to pay capital gains tax on the difference between the purchase price and the sale price. You also have to factor the improvements into the equation and will only pay tax on the remainder.
For example, if you purchase a car for $10,000, spend $2,000 improving it and then sell it for $11,000, it is considered a capital loss and you don't need to pay any tax.
But if that car sells for $15,000, you will have made $3,000 profit and will need to pay tax on that $3,000.
The amount of capital gains tax that you pay will depend on your income and filing status.
What About Sales Tax?
If you are the buyer and not the seller, you may need to pay a type of car tax in the form of sales tax. The rules on sales taxes differ from state to state but you will be charged by the state in which the car is registered and not the one where it is bought.
It means that you can't simply travel out of state to pay less sales tax or no sales tax at all. On the plus side, if you live in a state that doesn't charge sales taxes, including Oregon and New Hampshire, you won't pay taxes on vehicles purchased inside or outside your state.
The Bottom Line: Do I Pay Income Tax if I Sell My Car?
Generally speaking, you don't need to worry about tax if you're taking a hit on the sale of a car. Even if you're making improvements and increasing the market value, you won't need to calculate capital gains tax if you make a loss overall.
Just remember to keep the receipts and to show proof of capital loss, as the IRS won't just take your word for it.