Tax Considerations for Rental Businesses

Having apparently recognized the futility of extending a backward-looking tax incentive, Congress is now mulling a much earlier tax-extenders bill with respect to Section 179 and bonus depreciation for 2015.

Keeping up with tax changes can be a daunting, but necessary part of business operation. Here are some recent changes to tax laws that might directly affect your business:

  • Bonus Depreciation: The right to depreciate up to 50% of the cost of new equipment was scheduled to be phased out entirely at the end of 2014 but was extended at the last minute, on December 16, 2014, to apply retroactively to equipment purchases made in 2014 (but surprisingly, not into the future).
  • Section 179 Deductions: The valuable Section 179 deduction (giving purchasers the ability to write off up to $500,000 worth of both new and used equipment purchases, up to a $2,000,000 aggregate cap) was scheduled to be reduced to $25,000 in 2014 but was also salvaged on December 16, 2014, in the same “tax extenders” bill that revived bonus depreciation, but again, only for 2014.
  • 1031 or “Like-Kind” Exchanges: The ability to defer taxes on sales of used equipment, provided it is replaced with additional equipment within 180 days (subject to certain other deadlines) has been under assault on Capitol Hill, but fortunately, has not yet been impacted.
  • Capital Gains Rates: The Long-Term Capital Gains tax rate increased from 15% to 20%, with substantial direct impact on equipment sellers.
  • 3.8% Obamacare Tax: In an effort to provide further economic support for Obamacare, an additional 3.8% federal tax has been added to certain net investment income of individuals, estates, and trusts. Net investment income includes rental income, gains from the sale of investment real estate, and passive income in partnerships and Subchapter S corporations. 
  • Obamacare Employer Mandate Tax: If an employer does not offer health coverage, and at least one employee qualifies for a health tax credit, the employer must pay a non-deductible tax of $2,000 for every full-time employee. This provision applies to all employers with 50 or more employees. If any employee actually receives coverage through a state or federal exchange, the penalty on the employer for that employee rises to $3,000. 
  • Medicare Payroll Tax: The Medicare Payroll Tax also increased by .9% for single employees making over $200,000 per year and married couples making over $250,000 per year.
  • State Sales and Use Taxes: Many states have become considerably more aggressive in pursuing sales and use taxes from businesses operating across state lines.
  • Gas Taxes: Both the federal government and several state governments are considering raising their gas taxes, largely to pay for infrastructure projects.     

Looking Ahead

Having apparently recognized the futility of extending a backward-looking tax incentive, Congress is now mulling a much earlier tax-extenders bill with respect to Section 179 and bonus depreciation for 2015. However, congressional approval of a tax-extenders bill, permanent or otherwise, remains in doubt with the debt ceiling and the highway trust fund debates still looming.

The North American construction equipment market continues to grow. Unfortunately, this might reduce the perceived urgency of tax reform at the congressional level. If that happens, we could again find ourselves waiting until the end of 2015 for another one-year extension of these tax incentives, or worse, see Congress fail to approve any of them.

What to Do

One of the best options for equipment users remains the 1031 or “Like-Kind” exchange. This tax deferral mechanism provides a substantial incentive to purchase replacement equipment by permitting the disposal of used/depreciated equipment without incurring immediate income tax consequences on the sale, but only if they replace it with like-kind equipment within legally mandated, and rigid, timetables.

Obviously, being able use 100% of the proceeds of an equipment sale (as opposed to losing perhaps 35% or more in taxes) enables these users to buy more equipment from dealers, but it also potentially benefits dealers in another way. Dealers engaging in rental operations can take advantage of like-kind exchanges in the same way contractors and dedicated rental operators do, but only to the extent they sell “property held for productive use in a trade or business” (e.g., rental fleet, and not inventory held for sale). This “dual-use” question has been the source of considerable debate, and has prompted many dealers to set up entirely separate companies to house their rental operations and equipment in order to avoid the potential for future recharacterization, by an IRS auditor. Doing so is fairly simple, relatively inexpensive, and legally shrewd, as it also avoids exposing dealers’ non-rental assets to rental-related liabilities.

The ever-changing tax environment continues to create new challenges (and opportunities) for distributors and rental operators. Fortunately, sellers and purchasers still have some options with respect to tax planning, but as is so often the case, careful (and early) planning and preparation will be essential for those who hope to take full advantage of them.

James R. Waite, Esq., is a corporate and commercial equipment leasing attorney with over 20 years of experience. He authored the American Rental Association’s book on rental contracts and is the owner of EquipmentRentalContracts.com. He has represented dozens of equipment rental companies throughout North America. He is also a veteran of the United States Air Force, has a BBA in Finance from the University of Texas at San Antonio, a Juris Doctor from St. Mary’s University, and an MBA from the Kellogg School of Management at Northwestern University in Evanston, IL.  He can be reached at (866) 582-2586, or via email at: JWaite@wwlegal.net.

Contributing Authors:  Brent C. Abrahm, President & CEO of Accruit, LLC, and Steve Chacon, C.P.A. and Senior Managing Director, of Accruit, LLC.  Under a Joint Business Relationship with PwC, Brent heads the country’s largest personal property program exchange Qualified Intermediary. He also sits on the Executive Committee of the Federation of Exchange Accommodators (FEA), co-chairs the Government Affairs Committee and chairs the FEA’s PAC activity. He can be reached at (303) 865-7301, or via email at brenta@accruit.com.  Steve serves as the current treasurer for the FEA and serves on the FEA’s Government Affairs and Executive Committees.  He holds a Bachelor of Science degree in Business Administration with an Accounting Emphasis from the University of Colorado. He can be reached at (303) 865-7316, or via email at stevec@accruit.com.

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