Use the New Tax Bill to Your AdvantageBy Garry Bartecki
Article Date: 11-01-2010
Copyright(C) 2010 Associated Equipment Distributors. All Rights Reserved.
It may sound counterintuitive, but buying a depreciable asset before year’s end may be a solution to the tax liability some dealers and contractors are facing.
Another complicated tax bill comes our way, which should be used to both stimulate sales as well as manage your 2010-2011 tax positions. By the time you read this, the benefits related to 2010 may be restricted because of a lack of equipment. The 2011 benefits will, however, be available for all of 2011.
As we mentioned in prior articles, dealers and contractors have income tax risk to contend with, which can be mitigated by either the extension of the Bonus Deprecation or use of the Section 179 write-offs. This income tax risk results from the accel¬erated use of depreciation deductions or Section 179 write-offs that were used prior to 2010 to reduce taxable gains or to generate taxable losses that were carried back to recover taxes paid in prior years. This process of deferring taxes can be carried on as long as depreciable assets are purchased annually. Slow down or stop making purchases and you soon wind up with tax gains larger than book gains. And when that happens, you can guess the result – a tax bill, and in some cases a tax bill even though your books show a loss.
For example, let’s assume you purchase a $100,000 piece of new equipment that is considered a "busi¬ness asset" that is depreciable (either a rental asset or fixed asset on your books). This business asset for book purposes will be depreciated over five to 10 years and sold at some point during the first five-year period. Following this example, the book depreciation may be $10,000 per year and after three years the book balance is $70,000. For tax purposes, this same unit could have a tax basis of $0 to $70,000. If the remaining tax basis is $0 this means that you have depreciated the unit for book purposes for a total of $30,000, but have written off 100 percent of the $100,000 for tax purposes leaving $0 available for future tax benefits. So what happens if you sell the unit after three years?
Let’s assume you sell the unit for $80,000 at the end of three years. For book purposes you generate a sale of $80,000 and a $10,000 gross profit on the sale. For tax purposes you have a tax sales price of $80,000 and a tax gain (at ordinary rates). Wow, an $80,000 gain at ordinary rates plus a bank loan payable somewhere in the range of $50,000; a $10,000 book gain, a potential tax liability of $25,000 and a note balance due of $50,000.
$80,000 -$50,000 -$25,000 = $5,000 of cash flow.
Under normal circumstances a dealer or contractor could avoid these consequences by buying additional business assets to use the tax attributes of MACRS Depreciation, the Bonus Depreciation or Section 179 write-offs to offset the $80,000 gain referred to above. But this is not a normal year. It is a year in which dealers and contractors are selling off equipment to generate cash flow and have zero plans to purchase replace¬ment units. It is also a year in which units are being sold with zero tax bases, making the total sales price taxable for tax purposes. Let’s see: Selling off the fleet without replacements equals unexpected tax bill and estimated tax bill falling in the next 12 months.
The new federal tax bill, which reinstates MACRS along with the higher limits of $500,000 for Section 179, gives taxpayers the option of replacing a unit, which can be used to offset these taxable gains where the gains create taxable income even if the books show a loss for the year. It might be worth looking at if your choice is either paying taxes or replacing a unit for the same amount of money.
My belief is that many dealers and contractors have this tax risk to deal with and probably don’t know it – nor do they have the cash to pay the taxes. Consequently, it is very important to prepare tax projections for 2010 and 2011 to assess what this risk may be, and then assess if a purchase of depreciable assets makes sense for your situation.
All indications are that rental will become the major purchase alterna¬tive for contractors and, for dealers, this could somewhat mitigate the tax risk discussed above. Additions to dealers’ rental fleet in the remainder of 2010 could reduce the bulk of any unexpected taxes related to the 2010 year-end.
GARRY BARTECKI (email@example.com) is AED’s vice president of Finance.
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