Positive equity from Lease sale considered Income?

With the crazy used car market a lot of us have been offloading their leases to likes of Carvanas, Carmax, Vrooms of the world and making handsome profit in the profit.

Question I have is that will this profit need to be reported as Capital gain or any type of income during tax season.

I would be asking this to CPA come tax season but wanted to check with fellow hackers too.

Did your equity exceed your total lease payments/das to date?

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Short answer is no, at least in 99.9% of cases. Getting a check back for some positive equity after selling a car most definitely doesn’t automatically equal “income”.

As Matt mentions above you need to calculate your true cost basis on the car, which includes not only the sum of your paid lease payments and DAS, but also any other expenses you’ve incurred on the car, including insurance, maintenance, gas, tires, etc.

Assuming your equity check is less than the total of all that stuff above, then you didn’t realize any income.

Wrong answer. Unless you are talking about business owner, most of what you mention is not deductible. For capital gains tax calculation you take the proceeds of the sale and deduct cost of purchase + capital improvements if any (regular maintenance like oil change does not qualify). Insurance does not qualify, and interest (MF) does not qualify as a decuction either.


That is true for a loan purchase but how about lease as we actually don’t own anything. Just driving someone’s property and paying rent in a sense. In essence I sold someone else’s property gave them what I owed and kept the profit right.

That’s ultimately the issue. There doesn’t seem to be clarity on what the cost basis is. The payoff at the time of the sale seems like a pretty easy argument for IRS or any tax board to make. Since the lease payments were a ‘use charge’ of sorts, it’s probably not as straightforward as using the original cap cost as the cost basis.

That said, probably not something the IRS has had the bandwidth to rule on. But they usually have no qualms about making a ruling retroactive to the beginning of the year.

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Hope this will clarify a little bit.

“Almost everything you own and use for personal or investment purposes is a capital asset. Examples include a home, personal-use items like household furnishings, and stocks or bonds held as investments. When you sell a capital asset, the difference between the adjusted basis in the asset and the amount you realized from the sale is a capital gain or a capital loss. Generally, an asset’s basis is its cost to the owner, but if you received the asset as a gift or inheritance, refer to Topic No. 703 for information about your basis. For information on calculating adjusted basis, refer to Publication 551, Basis of Assets. You have a capital gain if you sell the asset for more than your adjusted basis. You have a capital loss if you sell the asset for less than your adjusted basis. Losses from the sale of personal-use property, such as your home or car, aren’t tax deductible.”

True & correct. The basic idea of a cost basis is that monies paid to “own” the property.

But in this case,
3rd party buyouts can be looked as a “brokered sale” transaction as you never take title of the property thus never owning the property but you receive the difference between the payoff & sale price.

So I would argue that this is straight up income to you & doesn’t fall into capital gain category.

Classic mixing of transactions.

You need to look at this as 2 separate transactions…

1st transaction Lease - you lease contract is a personal rent contract. This payments are not deductible on tax return. As it is a rental agreement, you never own the property & payments made are not considered as part of the cost basis. Compare it to you renting an apartment.

2nd transaction 3rd party buy out - you still don’t own the property thus see my explanation regarding considering it a broker sale transaction.

One may argue that you’re selling the option to purchase the vehicle under market value per your contract, so it isn’t two separate transactions.

Even if that’s what you argue that you’re merely selling the option like a stock option, the cost of the option is the price paid for it, you can’t add the underlying assets’ “strike price” in your cost basis calculation for the option.

I.e. - when you buy a call option (as that what is represents in this situation) for a strike price of $40 for $3 for a said stock your cost of the option is the premium you paid not premium you paid plus the strike price. To keep it simple (ignoring the fact that an option is for 100 stocks) you cost of the option is $3 not $43 ($3 + $40).

However, in this case this option has no cost to you as your lease payments are clearly identified as payments related to the use of the asset & you’re in no way contractually obligated to pay anything extra to have this option added to your lease contract to buy out the vehicle at the end of the lease.

No, the lease payments reflect the embedded call option in how they set the residual & mf rates, in theory payments would be less if there was no purchase option since the financing company would capture any equity income and therefore the actual depreciation they occur is lower for some percentage of transactions.

But your buy out price is directly tied to what you’ve paid already.

Your implication is that if two people leased the same vehicle for the same price but one put a large cap cost reduction up front, and then turned around and sold it, the person who paid the large cap cost reduction would owe significantly more taxes because of the higher equity, despite the same net cash flow before taxes?


Again let’s try to not to mix up the 2 different concepts here - Residiual vs The Option to Purchase the Vehicle

“Residual Value” - is what has direct impact on your actual “Lease Contract”

“The Option to Purchase” - Has no direct impact on your actual “Lease Contract”

Residual value is an essential element of the “Lease contract” whereas,

The actual clause giving the lessee “The Option” to purchase the leased vehicle at a set price is not an essential part of the “Lease Contract”. Contract does not become invalid if the option was removed.

Car lease contracts are “Close-End Lease” contract thus The purchase Option is not binding thus this assumption is not applicable.

Again this would only come into the play if the vehicle was purchased & then sold thus making it a completely different transaction as now you will own the asset & the initial “cap reduction cost” is directly related to the asset’s value that you paid out of your pocket making a stronger case for adding only the “cap reduction” portion to be included as your cost of the asset but again the acutal “lease payments” are still considered part of the “rental contract”…

How do you figure?

In the case where a 3rd party buy out is equally to your personal buy out less sales tax, the buy out amount is constantly varied based on the amount of money that you have paid; be it in cap cost reduction, direct lease payments, or extra payments beyond the minimum amount.

Let’s look at the latter case in more detail to explore you assertion:

Person A has a lease and makes the “normal”, contractually defined payment amount. After 1 year, they sell to a third party dealer who buys the lease out at the adjusted capital cost as defined in the lease contract. In this case there is 0 equity, so we can all agree there is absolutely no income or capital gains tax due.

Person B has the exact same lease and makes the “normal”, contractually defined payment amount plus an extra $100 per month. After 1 year, they sell to a third party dealer who buys the lease out at the adjusted capital cost as defined in the lease contract, which is $1200 less than Person A’s lease. They cut a check to Person B for the $1200 in equity.

Is you assertion than Person B owes income tax on the $1200 in equity, despite having an identical net cash outlay and having equity only as a direct result of the extra payments made during the lease period?

Why would a person do this when not required under a normal lease contract?

Also, i don’t think in a normal lease contract, additional payments go towards lowering the equity of the car but might be considered advance payment so the return of $1200 would be considered refund of the advance payments.

Isn’t the whole purpose of a lease contract is to limit liability to the predefined lease payments with exception of excess wear & tear in return for no equity?

Additional payments go towards lowering the adjusted balance, which increases the equity.

While I agree that extra monthly payments doesn’t happen often, a very similar version of that happens constantly, where someone makes an extra payment to lower the adjusted balance all at once.

That brings me back to your tax assertion. Does someone incur a tax liability for making extra payments that lower the adjusted balance, resulting in higher equity despite the same net cash flow?

If as you say, those extra payments specifically go towards reducing the “buyout” price then the extra payment is outside the scope of the required “Lease Agreement” thus making it additional capital outlay giving you “basis” & in return reducing any applicable gain, if there was any at the time of disposition & as it is a personal property, if there was a loss then it has no tax impact as it’s not deductible.

And if you were to have a lease contract that said that every lease payment reduced the cost basis, would you agree to the same, regardless of if it was an extra payment or not?

If you’re referring to the depreciation amount listed on the contract then No.

As depreciation is only allowed on assets you own. & In a lease contract you don’t own the car. You’re reimbursing the asset owner for the implied depreciation.

No, I’m talking about the adjustment of the pay off amount, exactly like the extra payments we were just discussing.

Let us circle back to the case of two identical leases, but one person makes a large cap cost reduction. They will have a lower adjusted cap cost and as a result, have more equity. Do they owe more taxes despite the same net cash flow? They certainly didn’t make more total income.