Whether you are thinking about tax savings or are merely in the market for new equipment, the end of the year is a good time to consider buying it.
Most builders and contractors will benefit from a full year’s worth of write-offs with only a month or two of payments, limiting the actual cash outlay for that new equipment while, at the same time, generating significant tax deductions for the 2008 tax year.
By waiting until January (for most of us using a calendar year), you will miss the current year’s Section 179 deduction — a whopping write-off for up to $250,000 in newly acquired equipment. Plus, there is also a 50 percent bonus depreciation deduction available for the purchase of qualifying property.
One of the most obvious strategies for small-business owners is to purchase furniture, office and other equipment — even business vehicles — near the end of the calendar year rather than waiting until the following year. Year-end purchases often can be expensed and written off or deducted from the tax bill for the current year. This means a rural building business or a business owner in the 25-percent tax bracket can effectively reduce the cost of those year-end purchases by 25-percent within just a few months.
Among rebates and business incentives of the Economic Stimulus Act of 2008, signed into law earlier this year, is a provision that nearly doubles the amount of deductible Section 179 expensing for 2008 to $250,000. At the same time, the threshold for reducing the write-off increased to $800,000. Unfortunately, it applies only to property purchased and placed in service in 2008.
Before the law changes, a contractor or building business could deduct or “expense” up to $128,000 of the cost of depreciable business assets for 2008. If the cost of qualified property placed in service during the year was more than $510,000, the ceiling for that business is reduced, dollar-for-dollar, by the amount over the applicable limit.
Under the new laws…
The new, temporary, rules make no changes to the general rules for types of property eligible for expensing. Generally, the property must be tangible or real property used in the trade or business and eligible for depreciation. The property must be used more than 50 percent for business, as well as have been newly purchased.
Although a more complete list of eligible Section 179 property is available in IRS publications or on the Web site (www.irs.gov), generally it includes computers, telephones, telephone systems, copiers, office furniture and equipment and property acquired for business purposes and used in a building business.
Investment property does not, of course, qualify for depreciation purposes, let alone Section 179 write-off.
Early in 2008, Congress resurrected bonus depreciation as part of the so-called “rebate” law changes in an effort to encourage business investment. The new law provides qualifying taxpayers 50 percent bonus depreciation of the adjusted basis of qualifying property, but only for that acquired in 2008.
To claim bonus depreciation, property must be (1) eligible for basic depreciation (the modified accelerated cost recovery system or MACRS, with a depreciation period of 20 years or less), (2) computer software (off-the-shelf) or (3) qualified leasehold property. Again, the property must be purchased and placed in service during 2008.
Questions to consider
Will the new equipment be purchased with borrowed funds? Or would it be more advantageous for the building operation to lease? Leasing might mean losing the tax benefits of first-year Section 179 write-offs as well as the 50 percent bonus depreciation allowance. Instead, the building business gets an immediate tax deduction for all lease payments. Also remember, under some circumstances, and with certain types of equipment, the full amount of the equipment purchase may be deducted in the first year.
The cost-reducing tax advantages under either the financing or the leasing option depend heavily on the situations of both the building business and its owner. By no means, however, should the decision be based solely on the first-year, out-of-pocket outlays.
Whether the building operation will benefit from newly-acquired equipment at year-end or, indeed, whether it will have the profits to take full advantage of year-end tax breaks and afford the out-of-pocket expenditures necessary to buy or lease that equipment will only become apparent as the end of the tax year approaches.
With a loan, a typical down payment is usually required. Most lenders want at least 10 percent or more of the purchase price as a down payment, although some may require more. However, when planning a year-end equipment acquisition via the purchase route, why not investigate seller-provided financing?
A large institutional lender is financing those purchases based on the building business’s financial history and prospects. Should the operation fail to repay the borrowed funds, the financial institution would, of course, take possession of the equipment. But, what would it do with the repossessed equipment and at what price?
Dealer, manufacturer or seller financing might, in some cases, be more expensive, but the up-front money is usually less. After all, if an equipment buyer defaults, the seller is in an excellent position to re-sell the repossessed equipment and can accomplish this far more efficiently and at a lower cost than a financial institution.
Acquiring equipment under a lease arrangement also involves certain upfront costs. The first and last lease payments may, for example, be required to enter into the lease. Although, in some cases, it may be possible to enter into a lease arrangement without an upfront payment, generally any advance payments required on a lease are less than a comparable loan down payment.
Particularly important today are interest rates. Although traditional loans are generally harder to obtain, interest rates are low. With a loan, the interest rate is the cost of borrowing money and explicitly stated in the loan agreement. With a lease, the implicit finance charge is rarely disclosed.
In fact, because of the way a lease is structured, it may be difficult to determine the interest rate. In some cases, a number of equal lease payments are due up front, plus the monthly payments over the term, plus a lump-sum payment at the end. Because the amounts of the lease payment are different, it is more difficult to determine the actual interest rate charged for a lease. But ask!
Owners of building businesses operating as limited liability companies (LLCs), S corporations or partnerships may be able to utilize Section 179 deduction, the 50 percent bonus depreciation or other tax breaks on both the business entity’s taxes and their personal taxes. Remember that many states restrict some deductions, so consulting a qualified professional is important.
This year, in addition to the benefits of a full year’s depreciation with only a month or two of payments, builders and contractors can further lower their actual tax outlays using the soon-to-expire tax breaks created by the “rebate” tax law passed earlier this year.
Year-end equipment purchases (YEEPs) are definitely the way to go. Or, perhaps, leasing is a more viable strategy. Either way, needed equipment added to the building business before the end of the tax year can be rewarding.
Mark Battersby is a tax and financial consultant, lecturer and writer with more than 30 years’ experience with small businesses issues. Contact him at 610-789-2480 or MEBatt12@Eartlink.net.