Contractors buying used construction equipment in 2018 and over the next five years will reap some hefty tax breaks, including one that was previously only available for purchases of new equipment.
The tax breaks come in two forms, section 179 and bonus depreciation, both of which now allow contractors to deduct 100 percent of the cost of new – and used – equipment in the first year they put the equipment into use. That also includes financed equipment.
“It’s a huge benefit,” says Ken Sibley, partner in charge of the Dallas office of Calvetti Ferguson CPA firm. “The used market now is really going to get a benefit because you can actually write the stuff off; whereas, before you couldn’t write it off as aggressively.”
Expanded deductions for equipment purchases
Under the new tax law signed by President Trump on Dec. 22, 2017, first-year bonus depreciation expanded to include used equipment bought and placed in service after Sept. 27, 2017. The first-year bonus deduction for all qualified equipment also increased from 50 percent to 100 percent of its cost.
Another provision of the new tax law increased the maximum depreciation deduction on section 179 property from $500,000 to $1 million and increased the cap on the equipment purchases from $2 million to $2.5 million. Those changes took effect Dec. 31, 2017, according to the Internal Revenue Service. Under section 179, equipment purchases are treated as an expense and deducted from income.
Both section 179 and bonus depreciation allow 100 percent write-off of the cost of used equipment in the first year. Both also stipulate the equipment must be put into use in the year the purchaser takes the deduction.
For example, if you buy a used backhoe this year but you don’t put it into service until 2019, you will have to wait until filing your 2019 taxes before taking either 179 or bonus depreciation. But if you put it into use the same year you buy it, you can deduct from that year’s taxes.
There are some other caveats, as well.
“The used equipment can’t be equipment that you’ve used before,” Sibley says. “It’s got to be new to you, and it can’t come from a related party. It can’t come from any of the associated companies in your control group or from a relative or anything like that.”
179 versus bonus
Though the benefits of 179 and bonus are similar, there are some significant differences.
“The major difference is 179 comes with a cap on the amount of expenditures,” says Paul Helderman, partner with WithumSmith+Brown CPA firm in Princeton, New Jersey.
For 2018, that cap is $2.5 million, at which point the deduction begins to phase out dollar-for-dollar and reaches zero at $3.5 million.
However, bonus depreciation does not have a cap. “So, if you can’t qualify under 179 because you exceed those thresholds, then the bonus depreciation can kick in,” Helderman says. “And you’d be able to claim 100 percent of that purchase price.”
Another difference: 179 is limited to taxable income. So, if you report a loss, you don’t qualify. But companies with an income loss can still deduct bonus depreciation, according to Richard Middleton, partner with Alloy Silverstein CPA firm in Cherry Hill, New Jersey.
“So that’s a big advantage,” Middleton says. “That’s something someone should consider when they’re deciding whether to use 179 or bonus depreciation.”
Typically, though, 179 is taken first, and then once the cap is reached, the business can take the bonus depreciation, accountants say. The 100 percent bonus depreciation is scheduled to start phasing out on Jan. 1, 2023, according to the IRS.
“Obviously, it’s a great benefit if their business needs include acquiring new or used equipment; it’s a good time to take advantage of that because it does go away after a while,” Helderman says. “These are expiring provisions.”
Planning crucial for max tax benefits
Though accountants agree the new tax law will be a big benefit for many firms purchasing equipment, as with any tax matter, there is more than just one variable to consider.
First, by taking 179 or bonus depreciation, you can’t depreciate that equipment after the first year.
“The benefit is you buy something, and you can write it off immediately, which saves you the taxes for that current period and you’re not spreading the cost out over five years or seven years,” explains Middleton. “The problem with writing everything off in that initial time period is you’ve got no depreciation expense going forward unless you buy more equipment.”
So whether you take the immediate write-off and how you take it can depend on your business’ future plans, what tax bracket you’re in and other considerations.
The new law also did away with tax deferral on equipment trade-in allowances, Helderman says. But the bonus depreciation can mitigate some of that lost benefit. Sibley added that this won’t likely be a big deal for many of his clients who keep their equipment so long as there is little recapture value left.
The states you do business in can also play a role in your tax decisions. Some states will follow the federal tax changes, but other states, particularly California and Northeastern states, tend to treat 179 and bonus depreciation differently, according to Sibley. Your depreciation choice on your federal return might not be the best choice for your state return.
“You really have to know what’s going on with your particular state,” Middleton says. “And if you’re a contractor that’s doing business in multiple states, that becomes a consideration because you’ve got potentially different rules for all the places. Planning is just so critical in all these decisions.”
Despite the need to plan, most contractors will find the new tax law beneficial when it comes to purchasing equipment, be it new or used, accountants say.
Helderman cites the finance concept of “net present value” – a dollar today is worth more than a dollar in the future because of potential earnings and inflation – in explaining the advantage of taking a write-off in the first year versus spreading depreciation over time.
“If you’re able to deduct the full cost of your equipment purchase in year one, you’re getting an immediate tax benefit versus having to spread it over five years,” he says. “A benefit today is worth more than a benefit five years down the road.”
The deductions also hold true for financing used equipment, which could enable the deduction to exceed the purchaser’s loan payments in the first year.
“You’re getting the deduction up front for tax purposes,” he says, “and you’re paying the equipment off over time at cheaper dollars because of that net present value concept.”
“You don’t typically use tax benefits as a reason to buy equipment, but if your business needs it for sound business purposes,” Helderman says, “it’s a good time to do it to take advantage of these tax benefits.”
EDITOR’S NOTE: This article was written by Don McLoud, managing editor of Equipment World, a sister publication.