Are Rental Units Depreciable? - On The Numbers
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SECTION: On The Numbers

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Contact Kim Phelan at (800) 388-0650 ext. 340.

Are Rental Units Depreciable?

Written By: Gary Bartecki

Article Date: 10-03-2005
Copyright(C) 2008 Associated Equipment Distributors. All Rights Reserved.

We thought we had the depreciation issue for rental equipment under control.

For years, dealers used either a percentage rent or lower cost or market approach to record an estimate of the diminution of the equipment value due to renting it. About 10 years ago, the IRS decided it didn't like any type of percentage rent and the ABC rental case appeared. As a result of ABC, dealers started switching to what they believed the IRS wanted and started using MACRS to deprecate rental units.

We went along fine with MACRS - which is the method all rental companies get to use - until a member was challenged in 2001 and the IRS agent stated the dealer was depreciating inventory, which was not an acceptable practice.

At this point AED stepped into the breach and with the help of Don Barnes, helped the member to prevail, in the process negotiating TAM (technical advice memorandum) 200203001, whereby a dealer could depreciate rental units.

In fact, the ruling stated that a pool of equipment could be depreciated, as long as more than 51 percent of the pool was rented at least one time. Here again, this is no different than a rental company that buys equipment and depreciates it even when it has earned no revenues in the tax year.

With this latest TAM in place, we all thought we had solved the depreciation issue and knew the rules for preparing business plans.

But now the IRS comes up with a proposed coordinated issue paper covering dual use property dated July 2005, which by and large states that units available for rent or sale are inventory and no depreciation is allowed. Their reasoning is as follows:

Inventory is not depreciable. Rent-to-sell units are primarily inventory in nature. The primary purpose is to sell the unit, and thus it is inventory.

Quite frankly, I couldn't believe what I was reading and then I found out there are agents out there using this proposed paper to initiate changes. Unbelievable!

The reasons agents get all worked up about this is because:

We classify rent-to-sell units as inventory. We
have contracts that allow the application of
rental payments against the selling price.

Let's face it, any asset you call "inventory" is going to raise a red flag if it is written down or depreciated. That's a big no-no as far as the IRS is concerned. And I don't care what kind of lost value you incur in the process, if you call it inventory, it will get challenged if you reduce the value.

So, the IRS goes through this elaborate explanation supporting why you can't write down units held for rental or sale and arrives at a conclusion that is 180 degrees from TAM 200203001.

In addition, they included a set of criteria that has to be met to allow the depreciation of a rental unit. Are you ready?

  • Inventory may not be depreciated.
  • Goods are presumed to be inventory if they are held for sale
  • If the gross selling price is more than 50 percent of the original cost, it is inventory.
  • If the gross rentals are less then the gross selling price of the goods, it is inventory.
  • If the rental period is less than half the useful life of the property, it is inventory.
To test the criteria, I prepared a model assuming 30-percent dollar utilization on a $100,000 unit over three years. I depreciated the unit using MACRS, 80/20 percentage rent, five-year straight-line depreciation and "sold" the unit at the end of year three for an 11 percent gross profit that was approximately 65% of original cost. Guess what? I didn't pass any of the tests!

It is obvious to me the IRS does not understand our business, and we don't help ourselves by calling rental units "inventory." They must think we're like car dealers that can put out units on demo for a year and still sell them for more than original cost. We all know that is not the
case in our industry.

The other revelation resulting from the model I prepared was that there was no material difference between methods used even if you included the write down of units to fair value.

No matter what, the industry must maintain the right to use MACRS to cover the loss of value associated with rental units. This loss of value is no different whether you call it a rent-to-sell transaction or a long-term rental asset. The decrease in value over the first three years will be the same assuming similar hour usage.

AED realizes the importance of this issue and has prepared a counter issue paper that was submitted to the IRS in early September. You can read both the IRS Position Paper and AED's response on AED's website at

Rest assured, AED will do all it can to educate the IRS about the nature of an equipment dealer's business and the various rental programs available to customers.

What can you do at this point?
Nothing really. As far as I'm concerned, it's business as usual until we hear back from the IRS.
You can review your accounting practices and contracts concerning these transactions to make sure you are properly accounting for rental units.

I will discuss this in future columns, but feel free to call me regarding this at 630-567-0650 ext. 323.

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