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Tax Management Solutions for Large Asset Purchases

Some businesses are continuing to struggle financially from the effects of COVID-19, making cash flow a chief concern. When cash is tight, businesses have a harder time planning for large purchases. Fortunately, there are a few tax deductions that can make these cash outlays a bit easier to stomach. One of these tax management solutions is bonus depreciation.

What is Bonus Depreciation?

Bonus depreciation allows businesses to depreciate qualifying property at an accelerated rate. Instead of taking tax deductions for the cost of an asset over its useful life (or to the extent an asset will be used in the business), bonus depreciation front-loads a larger percentage of the deduction into the tax year the business starts using the asset.

Qualifying property is any asset that has a recovery period of 20 years or less using the IRS-approved modified accelerated cost recovery system (MACRS). This includes assets like machinery, equipment, computers, appliances, furniture, and vehicles. Prior to the TCJA, only new assets were eligible for bonus depreciation, but the definition has since been expanded to include certain used property as well.

Bonus depreciation may now also be taken on qualified improvement property (QIP). This means that if a business makes certain improvements to the interior of a commercial building, such as any electrical or plumbing upgrades, interior door replacements, drywall replacement, etc., then the business may be able to accelerate depreciation on the total cost of the improvement efforts. Not included in the QIP definition are elevators and escalators, enlargements to the property, or enhancements to the internal structural framework of the building.

The TCJA also widened the scope of bonus depreciation by including ”non-tangible” assets such as qualified films, television, and live theatrical productions that were acquired after September 27, 2017, as qualified property.

Currently, bonus depreciation is set at 100%. This means that 100% of the cost of the items can be deducted the year the asset is placed in service. Unfortunately, bonus depreciation is set to phase out. The bonus percentages over the next few years are as follows:

  • 100% for 2021
  • 100% for 2022
  • 80% for 2023
  • 60% for 2024
  • 40% for 2025
  • 20% for 2026
  • 0% for 2027 and beyond

Tax Management Solutions for Bonus Depreciation

Accelerating depreciation deductions can reduce your clients’ tax liability, and if you have a good-quality tax planning software like Corvee’s, you can show your clients how much a difference bonus depreciation could make. But there are other tax implications of purchasing new business assets beyond bonus depreciation. For example, if your client purchases new computer equipment to replace older models, they’ll need to dispose of the old equipment. This could result in a taxable gain or loss when your client reports the disposition to the IRS. As advisors, you must consider both the purchase and the sale/disposition of the asset being replaced.

Bonus depreciation is not mandatory, so your clients may opt to forego the accelerated deduction. Depending on their situation, it may make sense to deduct the cost of the asset over several years using traditional MACRS depreciation, or to leverage bonus depreciation in later years when they have more taxable income to report. Regardless, bonus depreciation can play an important role in multi-year tax planning. Corvee’s tax planning software can help you generate these multi-year tax strategies to individualize your planning approach.

It’s also important to consider that not all states follow bonus depreciation. Many states have their own depreciation calculations, so even if bonus depreciation brings your client’s federal taxable income down to zero, they may have state tax liabilities to report.

Non-Tax Considerations for Bonus Depreciation

Even though bonus depreciation can reduce tax liabilities, it will not be a good option if your clients don’t have the cash flow or debt capacity to purchase new assets. Yes, bonus depreciation can help businesses recoup those costs quickly, but a business must still be able to float those costs until they recognize the tax benefits. Before you even begin looking at bonus depreciation, make sure they can safely purchase or finance large asset purchases.

Bonus depreciation affects your clients’ tax returns, not their financial statements. When your client prepares their financial statements, they will expense the purchase using their chosen depreciation methodology, which means the purchase will get expensed slowly over the life of the asset. Their tax and book depreciation schedules are mutually exclusive. If your client elects bonus depreciation, they may have higher book income than taxable income. This may not be cause for concern if your client and their fellow owners understand the business’s chosen depreciation methodologies, but it could matter in other situations. For example, many banks will extend financing to a business based off their financial statements. Even if a business looks successful from a tax perspective, they may not look as successful from a book perspective.

Planning for Large Asset Purchases

While it wouldn’t be smart for a business to financially overextend themselves if cash flow is a concern, it may make sense for a business to adjust their purchasing strategy over the next couple of years to take advantage of bonus depreciation before the provision sunsets. Some possible options include:

Improving cash flow.

If your clients improve cash flow, they will have the cash they need to purchase bonus-eligible assets. These could be simple changes like instituting credit checks, offering discounts for early payment, keeping tighter control on inventory, accepting electronic payments, or choosing different suppliers.

Financing asset purchases.

If your clients can’t afford to purchase assets outright, they could consider financing their purchases using a bank loan, a Small Business Administration (SBA) or other government-backed loan, or specialty equipment financing loan. Debt isn’t always a bad thing. Yes, your clients will pay more for an asset if they finance its purchase, but if interest rates are low, the tradeoff might be worth it in the long run.

Applying for a line of credit.

Taking out new debt for an asset purchase might be a bit of a hassle, but your client might have a line of credit already established at their bank for just this purpose. Review your client’s bank offerings to see if a line of credit can bridge the cash gap.

Raising capital through equity financing.

Selling a portion of business ownership to new investors isn’t going to be the right option for everybody, but when businesses are looking to expand, raising capital by selling equity is a viable option.

Keep in mind that leasing assets is not an option for bonus depreciation. A business must purchase the assets to be eligible for accelerated depreciation.

How Corvee’s Tax Planning Software Can Help

When calculating tax strategies for your clients’ businesses, Corvee’s tax planning software can show just how much 100% bonus depreciation can save them on taxes. It can also project their tax position forward to determine if taking depreciation in future years may prove more beneficial. If you’d like to see how the depreciation module works in our tax planning software, reach out today for a demo.

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