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Business Tax Increase for 2012

  by Mr. Terry Winders

Congress did not extend for 2012 the President Obama stimulus 100% bonus depreciation benefit (1), this then becomes a tax increase, eliminates a stimulus also to acquire equipment, perhaps catches higher taxes in early disposal of equipment as per the IRS guidelines, and definitely affects the equipment leasing and finance industries. It is not helpful to small business in the United States.

Existing short term “true leases” are still available, but those leasing for cash flow with a bargain purchase option, we are back to MACRS depreciation and the percentages of the original fair market value allowed for each year based on the allowed term.

Here is a copy of the IRS’s depreciation schedule that gives you the asset class life and the allowable depreciation percentage for each year based on the class life. (2)

Prior to 2012 the business tax payer could fully deduct the equipments cost in the year it was acquired up to specific dollar amounts, as regulated and defined by IRS guidelines. With less depreciation available in 2012 from assets purchased the last few years, clearly the income tax bill will be higher. In addition if a business decides to replace any asset, the selling price will be fully taxable because the tax basis (undepreciated value) will be “0” because they took 100% of the purchase price off their taxes when they acquired it. So with limited deductions the business tax bill will be much higher.

Some will use the like-kind exchange program (IRC Code section 1031) and acquire like kind replacements so the tax burden is deferred into the future. Kicking the can down the road so to speak. The requirements are to qualify as a Section 1031 exchange; a deferred exchange must be distinguished from the case of a taxpayer simply selling one property and using the proceeds to purchase another property (which is a taxable transaction). Rather, in a deferred exchange, the disposition of the relinquished property and acquisition of the replacement property must be mutually dependent parts of an integrated transaction constituting an exchange of property. Taxpayers engaging in deferred exchanges generally use exchange facilitators under exchange agreements pursuant to rules provided in the Income Tax Regulations.

Real property and personal property can both qualify as exchange properties under Section 1031; but real property can never be like-kind to personal property. In personal property exchanges, the rules pertaining to what qualifies as like-kind are more restrictive than the rules pertaining to real property. As an example, cars are not like-kind to trucks.

An example of a like-kind exchange comes when a company wants to acquire a replacement piece of equipment. Let’s say they have an asset they wish to replace that was 100% depreciated in the year they purchased it. Now it has a sale value of 50% of its original cost. If it was just sold it would be taxable event at a 35% rate. In a like-kind exchange the new equipment purchase value will be 100% minus 50% so it will go on the books as a 50% asset and that amount will be depreciated according to MACRS with no tax effect. Then if the second asset is sold in the future, its lower tax bases may cause a taxable event unless they do an additional like-kind exchange on it.

It is important to know that taking control of cash or other proceeds before the exchange is complete may disqualify the entire transaction from like-kind exchange treatment and make ALL gain immediately taxable. If cash or other proceeds that are not like-kind property are received at the conclusion of the exchange, the transaction will still qualify as a like-kind exchange. Gain may be taxable, but only to the extent of the proceeds that are not like-kind property.

One way to avoid premature receipt of cash or other proceeds is to use a qualified intermediary or other exchange facilitator to hold those proceeds until the exchange is complete. Be careful in your selection of a qualified intermediary as there have been recent incidents of intermediaries declaring bankruptcy or otherwise being unable to meet their contractual obligations to the taxpayer. These situations have resulted in taxpayers not meeting the strict timelines set for a deferred or reverse exchange, thereby disqualifying the transaction from Section 1031 deferral of gain. The gain may be taxable in the current year while any losses the taxpayer suffered would be considered under separate code sections.

When the replacement property is ultimately sold (not as part of another exchange), the original deferred gain, plus any additional gain realized since the purchase of the replacement property, is subject to tax.

Because of the complex nature of like kind exchanges and the outside expense for a qualified intermediary most of these transactions are going to be for higher transactions.

Of course none of this has anything to do with a lease because title must rest with owner each time unless it is a bargain option lease where the lessor is one and the same each time.

A true lease may help a lessee from the heavy tax burden instead of a like-kind exchange when the use of the equipment is much shorter than the asset class life for federal income tax. A true lease will increase the tax write off if the term of the lease is short or a higher/lower rent stream is arranged. This would allow the lessee to expense the rents that should be higher than MACRS depreciation.

If cash flow is a problem because of the higher taxes leasing can offer a low/high rent program to lower payments in the months requiring tax payments. True Leasing is a very flexible product when considering how the payments are expensed for tax purposes. However the new accounting rules will flatten it out for book purposes.

(1) Accounting Web on Business Tax Credit

(2) IRS Depreciation Schedule (personal property)