How to Legally Avoid Paying Sales Tax on a Used Car

The used car market boomed in the wake of the coronavirus pandemic. With new vehicle inventory disrupted by supply chain issues, consumers turned to used cars. According to the Consumer Price Index, used car prices soared up 45% in the 12 months ending in June 2021. Now, they've seen a 12-month drop of 8.8% in the most recent reading for December 2022.

Even with the steep drop, you still want to lower costs wherever you can. One way to do that is by avoiding (or at least lowering) sales tax on a used car. Here are six tips for doing just that.

What is sales tax?

Sales tax is a local tax charged by your state and local government on eligible purchases. These taxes are based on the cost of goods and services rather than your income or assets, and they ensure that everyone who participates in the local economy is contributing to the community's budget for government services.

Depending on where you live and how much you buy, sales tax rates could have a substantial impact on your finances. Because of this, many consumers seek out strategies to reduce the sales taxes they pay on their purchases. This is especially true when they buy a big-ticket item such as a new or used car.

How sales tax on used vehicles works

Sales tax amounts on used vehicles vary depending on the state, ranging from around 3% to 8% or more of the vehicle’s purchase price. You may also have to pay an excise tax, which is another tax state and local governments can impose. If you purchase a used vehicle from a car dealer, you’ll likely take care of sales taxes, along with any other taxes due, at the dealership.

If you buy from an individual, you’ll likely pay taxes along with registration fees when you title your vehicle at the Department of Motor Vehicles. Be sure to get a bill of sale from the seller when you purchase the vehicle, as your sales tax is based on the purchase price.

You might think that paying for your used vehicle with a trade, such as building a new porch for a friend or swapping your compact vehicle for a truck, would eliminate sales taxes. Unfortunately, that’s still a taxable transaction, and the amount of tax would be based on the service you provided or the vehicle you swapped instead of the vehicle sales price.

6 ways to avoid paying sales tax on a used car

Depending on where you live and where you buy, there are different legal ways you might be able to use to avoid paying sales tax on a used car.

Live in a state without sales tax

One of the easiest ways to avoid sales tax on a used vehicle purchase is to live in a state that doesn't charge sales tax. You don't have to do anything different, and you can focus on finding the right car at the best price. This also keeps you from entering any gray areas that might get you in trouble if you miss a step or do something incorrectly.

These five states don't charge sales tax on used cars registered within the state:

• Alaska
• Delaware (no car tax on used or new cars)
• Montana (no car tax on used or new cars)
• New Hampshire
• Oregon

Additionally, Washington, D.C., does not charge sales tax on vehicle purchases.

Purchase your vehicle before moving

If you live in a state that doesn't charge sales tax, but you’re planning to move to one that does, consider buying your car before you move out of state. This way, you can buy and register your used car in your current state to avoid paying sales tax, then register it in the new state once you move.

Similarly, if your current state has a lower sales tax rate than the state you’re planning to move to, consider taking advantage of the lower rate and buy before you move.

This strategy is also effective for people who have multiple homes. Many households move according to the season, enjoying warm weather and long days in northern states during the summer, then heading south for the winter. If one of your homes is in a state that doesn't charge sales tax on cars, make your purchase during the time you're living in that home.

Buy in a state with lower sales tax

Sales tax rates vary widely from state to state. You may be able to buy a used car in a state with a lower sales tax rate and then register it in your own state. However, most states want to collect sales tax whenever they can.

When you register the vehicle in your home state, the DMV registrar may ask to see the purchase agreement to verify that you paid car sales tax when you bought the car. If you can’t prove that you've already paid taxes, you may have to pay them again.

For situations where you paid a lower sales tax in another state, you may have to pay the difference in sales tax rates when you register your car in your home state.

This happened to me when I bought my used car in Indiana. I found a better deal in Indianapolis, so I drove a one-way rental from Nashville, Tennessee, to close the deal. Indiana's sales tax is 7%, and that's how much I paid when I bought the car. However, when I registered the car in Tennessee, I paid the difference in sales tax so that I paid the full 9.25% on my used car.

Every state is different, so check with your local department of revenue to find out how they treat these transactions.

Have your LLC buy your vehicle in Montana

When you're buying an especially expensive vehicle, such as a used RV or luxury vehicle, it may make sense to implement this strategy. It’s complicated, so you may not want to deal with the time and effort for a less expensive vehicle. You may be able to establish a Limited Liability Company (LLC) in Montana and have it buy the vehicle to avoid paying sales tax.

The LLC is registered and located in the state, and your vehicle remains registered there as well, even if you live somewhere else. Although this process may sound complicated, there are services that handle the paperwork for you.

Keep in mind that this is very much a gray-area strategy. If your state finds out about the scheme, it may try to assess sales or use tax anyway. Some people have fought their states and won, but not without the added headache of time spent and legal fees paid to fight the lawsuit.

Negotiate a better deal on the vehicle

Part of knowing how to manage your money effectively is learning the art of negotiation. If you’re unable to avoid paying sales tax on a used car, the next best option is to lower that bill as much as possible by negotiating the car price. Although dealerships keep within a consistent range on new cars, the value of used cars varies widely. The condition of the vehicle is a matter of opinion, which leaves a lot of room to negotiate the price.

Remember, the lower that you can get the purchase price, the lower your sales tax will be.

You can increase your chances of finding a great deal in the following ways:

• Be a cash buyer. If you’ve saved up for a car and have the cash on hand, that's a better option for the seller rather than hoping a buyer gets approved for an auto loan.
• Search for desperate sellers. Some owners need to sell the car in a hurry. They're moving, getting a divorce, owe a major bill, or have another reason to sell quickly. You might be able to get a better deal by helping them out with an influx of cash in exchange for their vehicle.
• Look for cars that have been listed for a long time. If the car is not selling, the owner may be a good target for an offer with a substantial discount.
• Buy from a private party instead of a dealership. You'll often find a better deal when buying from an owner through a private party sale versus buying the used car at a dealership. Dealerships have overhead and are trying to make a profit, and the salesperson wants to earn a commission. The private party seller just wants to get rid of the car.

Trade in a vehicle

When you trade in a vehicle when making a car purchase, you can legally reduce the sales tax. The sales tax on your new-to-you used car is based on the difference in value between the vehicle you're buying and the car you're trading in. For example, if the used car you're buying is worth $15,000 and your trade-in is worth $5,000, you would pay sales tax on the $10,000 difference.

This benefit is not available in every state, but it is available in the majority of them. There are three states and Washington, D.C., that do not provide a sales tax credit on a trade-in:

• California
• Hawaii
• Virginia

See if you qualify for an exemption

An exemption is when you’re not required to pay sales tax on a vehicle purchase, even if your state charges sales tax. Sales tax exemptions vary, but in general, historic vehicles and vehicles used for farming aren’t subject to sales tax. You may also be exempt if the transfer of title is due to divorce, the vehicle is being purchased by a church, or if the vehicle is inherited.

FAQ

Bottom line

Buying a used car not only saves you money on a vehicle, but it can also save money on taxes. Although purchases generally result in sales tax in most states, there are ways to reduce your sales tax on a used vehicle. If you’re tempted to get around sales tax by leasing a vehicle, that won’t work, unfortunately. Sales tax is also charged when you lease a vehicle.

Sales tax is just one of the many taxes that Americans pay. If you're looking to reduce your taxes, read our review of the best tax software programs to see how much you can save.