A reason to invest in equipment now

By and |  October 23, 2013

Thanks to the American Taxpayer Relief Act, portable plant operators who have hesitated or postponed making capital investments because of the recent economic downturn might now want to consider how using those tax incentives can substantially reduce the cost of equipment. That’s right, large purchases, including equipment acquisitions, just became easier – and less expensive – thanks to new tax breaks and financing options created by lawmakers.

Those incentives include a unique first-year write-off for so-called Code Section 179 equipment 1040and property. The tax break that allows profitable operations and other businesses to write-off large capital expenditures immediately – rather than over time – has also been resurrected to allow a 50 percent “bonus” depreciation write-off for property placed in service through 2013.

To buy or to lease
Even as credit becomes more readily available, many businesses face the question of whether to buy or to lease. For some, purchasing needed equipment may not be an option because the initial cash outlay is too high.

Even if the business plans to borrow money and make monthly payments, most banks require a down payment of about 20 percent. Borrowing money may also tie up lines of credit, and lenders may place restrictions on future financial operations to ensure the loan will be repaid.
Equipment leasing is generally a loan in which the lender buys and owns equipment and then “rents” it to the business that will actually be using it at a flat monthly rate for a specified number of months. At the end of the lease period, the business may purchase the equipment for its fair market value (or for a fixed pre-determined amount), continue leasing, lease new equipment, or return it.

Deciding the best strategy is a tough move, and there is no one, correct answer that fits every situation, nor every business in need of a portable plant. For most leasing situations, however, there are rules that can help determine whether a transaction is a genuine lease or a disguised purchase. The rules evolved from a series of court decisions and IRS rulings. Generally, when it comes to determining who is the owner of the property for tax purposes, the IRS looks to the “economic substance” of the transaction – how it is structured and works – not how the parties involved characterize it.

There is no time limit on leasing. In fact, leasing is effective even where a business has already purchased equipment. These transactions, known as sale-leasebacks, are usually available for equipment purchased within the past 90 days. Sale-leasebacks may also be used to legitimately shift the tax benefits from the business to its owner or shareholders.

Although one recent Equipment Leasing Association survey found that almost 70 percent of those surveyed leased equipment, lease financing is generally more expensive than bank financing. Of course, in most instances, leases are more easily obtained.

In addition to the buy/lease conundrum, many businesses must answer the question of whether to replace or repair equipment. In an attempt to resolve the controversy over whether certain expenditures a business make are currently deductible as repair expenses, or whether they must be capitalized and deducted over the life of the underlying business asset, the IRS recently issued new guidelines.

According to the IRS, expenditures are currently deductible as a repair expense if they are “incidental in nature and neither materially add to the value of the property nor appreciably prolong its useful life.” Expenditures are also currently deductible if they are for materials and supplies consumed during the year.

On the other hand, expenses must be capitalized and written-off over a number of years if they are for “permanent improvements” or “betterments” that increase the value of the property, restore its value or use, substantially prolong its useful life, or adapt it to a new or different use.

Mark E. Battersby is a freelance writer who has specialized in taxes and finance for the last 25 years.

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