The clock is ticking on taking advantage of the "depreciation bonus" on new equipment.
The temporary special depreciation allowance permits purchasers of new equipment to write off more of the cost of equipment "up front" the first year, thereby reducing tax liability that year and improving cash flow.
The allowance, which expires at the end of 2004, allows immediately depreciating 50 percent of the cost of the equipment, plus in many cases, another 20 percent of the remaining amount of undepreciated value. For a $100,000 machine with six-year depreciation life, that's a depreciation of $60,000 for the tax year in which it's placed in service, and a tax saving of $16,000.
"To take advantage of the bonus, you must acquire the equipment, and place it in service, by the end of 2004, so don't waste time," said Christian A. Klein, Washington, D.C., counsel of the Associated Equipment Distributors (AED) headquartered in Oakbrook, IL. "We are reminding people that the new law is out there and that it expires at the end of the year."
A tax deduction of 30 percent on the cost of new equipment was one of the major provisions of the 2002 Job Creation and Worker Assistance Act enacted in March 2002. The deduction was increased to the current 50 percent under the Jobs and Growth Act signed into law in May 2003.
"AED has worked very hard to get the word out on this opportunity for purchasers of new equipment, creating a special Web site [depreciationbonus.org] and working with the Association of Equipment Manufacturers [AEM] to produce a brochure on this special allowance which is available free on the Web site," Klein said. "More than 65,000 copies of the brochure are in circulation in the construction industry. We sent free copies to our members and members of other construction trade organizations."
The 2003 law also increased the amount companies can expense, rather than depreciate, under Section 179 of the Internal Revenue Code, from $25,000 to $100,000 (see Expensing Bonus on page 47.)
How to Qualify
"There are basically four hoops you must jump through to qualify for the bonus," Klein said, explaining as follows:
1. Equipment must be a specified type — depreciable under the Modified Accelerated Cost Recovery System (MACRS), with a depreciation life of 20 years or less. The vast majority of construction equipment fits under this category.
2. The equipment must be new "original use". In creating the temporary bonus, Congress really wanted to stimulate business investment in new capital goods like construction equipment. A contractor renting a piece of equipment can only claim the bonus if the equipment was new when he or she started to rent it (first use) and if the contractor purchases it within three months of the rental start. (This would be a rent-to-own transaction, frequently used in the equipment industry).
3. To qualify for the 50-percent allowance, the equipment must be acquired after May 5, 2003, and before Jan. 1, 2005. Property put in service between Sept. 10, 2001, and May 6 2003, still qualifies for the 30 percent depreciation bonus enacted in 2002.
4. The equipment must be placed in service before Jan. 1, 2005.
Stimulates the Economy
"The 2002 and 2003 tax laws recognized that what really caused the economic downturn was a big drop-off in business purchasing," Klein said. "The temporary depreciation bonus is credited by some as the single most important factor in helping revive the U.S. economy. Congress perceived that the best way to get the economy going again was to temporarily stimulate this purchasing.
"The bonus is temporary, only applying to new equipment. The original 30 percent bonus was set to expire Sept. 11, 2004, under the 2002 law. It was then raised to 50 percent and extended to the end of this year under the 2003 law.
"From our [dealer] perspective, the stimulus has been very, very effective. Gross domestic investment in equipment and software reversed itself from negative to positive after the original depreciation bonus was enacted in 2002. The U.S. had experienced five consecutive quarters of low or negative growth in gross domestic product [GDP] before that, attributable in large part to a substantial drop in business purchasing.
"AED sponsored a survey study of the membership of the National Utility Contractors Association [NUCA] in May, 2003, which showed that the bonus was an important factor in purchasing equipment. There's absolutely no question that it helped sell machines. The single most important finding of the NUCA/AED survey was that 67 percent of the respondents who were aware of the new depreciation allowance said it had prompted their companies to invest in new equipment in the previous 12 months. At that time, 90 percent said that expanding the allowance from 30 to 50 percent would lead their companies to purchase, or consider purchasing, new equipment.
"We are not under any illusions that the bonus is the only factor in a person's decision to buy. Contractors buy equipment because they need to use equipment. In the overwhelming majority of cases, however, the bonus is a strong factor. If contractors are on the fence about whether or not to buy a piece of equipment, the bonus is certainly an effective way to nudge them off the fence."
Frequently-Asked Questions
AED's depreciationbonus.org also addresses some frequent questions on the bonus.
Does a customer have to claim the allowance?
No. The law allows customers to opt out and depreciate according to normal depreciation rules and schedules.
What about future depreciation?
The answer is that, if you depreciate more now under the new allowance, you depreciate less in the future. That means that your tax bill in the out years may be higher because you have less to depreciate.
Will the depreciation bonus be extended?
Probably not. AED says the odds are 20:1 against extension, explaining: "Economy is recovering. Money is tight in Washington. Depreciation bonus is powerful medicine. (Put it back in the medicine cabinet for next time.)"
What's the difference between the depreciation bonus and the investment tax credit?
The depreciation bonus allows you to deduct more than your gross income and thereby reduces your tax liability in reducing your taxable income. A tax credit, on the other hand, is a direct credit against taxes owed.
Will the bonus reduce my overall tax liability?
The bonus means you can write off more of the cost of new equipment up front, but it doesn't increase the overall amount you can depreciate. This means you'll still ultimately pay the same amount in taxes. (Your tax liability in later years will be slightly increased over what it would have been to make up for your near-term tax savings.) The advantage of the new law is that your tax liability for the purchase year will be reduced and your cash flow will be improved.
Suggestions
The Web site also offers these suggestions:
• No matter what kind of year you're having, make sure you know what your tax situation is. Your book situation may be different from your tax situation.
• Don't forget about the estimated tax payment impact on cash flow. The depreciation bonus can help push out tax liability.
• Purchasers should place orders now. "Dealer stocks are already tight," the Web site says. "We expect an upsurge in demand towards the end of the year as purchasers rush to take advantage of the depreciation rules before they expire."
Further information is available on depreciationbonus.org or by contacting Klein at caklein@aednet.org or 703/739-9516.
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