by Kris Houghton, CPA, Meyers Brothers PC
Each year, many business fail to realize all the potential tax benefits associated with the acquisition of capital assets. Sometimes more importantly they fail to fully understand how these benefits increase cash flow. Most specifically, they do not avail themselves of the election to expense a portion of their current year acquisitions and they fail to realize losses on automobiles when they trade them in.
EXPENSE TREATMENT FOR SMALL BUSINESS INCREASES
Since 1982, the Internal Revenue Service (IRS) has allowed small businesses to elect to expense or write off certain types of purchased business property rather than having to capitalize and depreciate them over time. There is a tax benefit in the rapid write-off because the business gets the full deduction for the equipment purchase in the year it acquires the equipment, rather than over the depreciated life. This deduction will shelter income from taxes based on the tax bracket of the business and/or its shareholder. For example, an “S” corporation whose Massachusetts’ shareholder is in the top tax bracket will save almost 45% of the qualified expenditure in taxes because of this provision. Hence the cash flow increase.
Starting in 1999, taxpayers who purchase qualifying business property will be able to write off up to $19,000 (up from $18,500 in 1998) of the purchase price in the year acquired. In 2000, the write off increases to $20,000.
Of course there are limitations on the amount and type of property that could be expensed. For example, equipment purchases over $200,000 go towards reducing the amount available for the election dollar for dollar until the benefits are completely phased out. In 1999, the benefit is fully phased out when equipment purchases reach $219,000. To be eligible for the election, qualifying property must be used 50% or more for business. For example, Joe purchased a computer, which he uses both in his business and personally. In the year he acquired the computer he used it 40% for business and 60% personally. Joe was unable to use the expense election because his business use fell below 50%. If his computer is otherwise deductible he will still be able to write off his business use by depreciating his computer over 5 years.
Certain types of property such as real estate, lodging or passive activity property are not eligible for the election.
Your tax advisor can show you how to take the best advantage of the small business election to expense your equipment purchases as well as the cash flow benefits that should be evaluated as part of this process.
TRADING IN YOUR BUSINESS VEHICLE
Do you write off costs associated with your business auto? If so, you should give as much thought to the tax consequences of selling your vehicle as you did when you bought it. A tax trap may catch you if you don’t carefully consider the decision whether to “trade-in” your vehicle or “sell” outright.
Trade-ins are subject to the like-king exchange rules, which means that no current gain or loss is reported in the year of sale. If you trade-in your vehicle, the use of the like kind exchange rule is required and not elective. Of course, this is good if you have a gain because you get to defer it; however, if you have a loss you may want to use the loss to offset current income.
With today’s auto depreciation limits it’s easy to end up with a high-cost vehicle which has a fair market value less than the tax basis (cost less depreciation). Rather than losing the current benefit of the loss in a like-kind exchange, you should sell your old vehicle outright for cash. This will allow you to take the loss in the year of sale.
Let’s look at an example. Suppose you purchased an Explorer to make business deliveries. You paid $32,000 for the vehicle but now you realize it’s not big enough to do the job. You took one year of depreciation at $3,060 leaving a tax basis of $28,940 ($32,000 – $3,060). Because of the heavy mileage you’ve put on the vehicle the fair market value is only $24,000. If you sell your Explorer outright you will be able to take a loss in the current year of $4,940 ($24,000 sales price less $28,940 tax basis). If you trade in the Explorer that loss will be deferred into the new vechicle’s basis and won’t be available for you to use this year. Further, the new vehicle will be subject to the depreciation limits as well. Your tax advisor can calculate the tax basis of your business auto and help you determine whether you’re better off selling your vehicle and taking the loss or trading in your vehicle and rolling your gain into your new purchase. Additionally, if you own larger style SUVs or trucks, you should verify the gross unloaded weight of your vehicle to determine if the depreciation limitations apply.
“FINAL THOUGHT”
A common mistake made relative to depreciation is limiting vehicles that fall outside of the general rule that allows larger style SUV’s and trucks to qualify for full depreciation due to their gross unloaded weight. A very effective alternative to the troublesome depreciation limitations on vehicles would be to lease. Then rather than purchase, this will be a future article to look for from your business partners at Meyers Brothers, P.C.