It’s that time of year again, when nearly everyone on the planet becomes a tax expert. Small wonder that the IRS instituted a mandatory registration and education program for all who hold themselves out as tax preparers. The buzz this year? "Oh look! I can write it off!" The bad advice I overhear irks me no end.
One of my mentors, long ago, had a rule for his clients: do not make business decisions based solely on the tax ramifications. I couldn’t agree more, and have continued to advise my clients the same.
Manufacturers started salivating when the section 168(k) deduction (that’s bonus depreciation in layman’s terms) was extended, and the section 179 deduction increased late last year. (1)(2)
If you really need that piece of equipment, fine. Planning the timing of the purchase makes complete sense. Even so, if someone’s trying to sell you a fancy new widget-maker, and the only advantage to the purchase they can come up with is the great tax savings, walk away. Why aren’t they telling you how their product will increase your production or your efficiency?
Worse, if they’re trying to sell you a piece of equipment to start a new business, they’re probably the only ones who stand to gain; they’re likely selling you a pig in a poke or something that’s going to depreciate as soon as you take possession. You’ll be upside down in your loan and possibly unable to sell or trade the equipment, as the next best thing is no doubt just around the corner.
Step back and take a breath. Hire a CPA with expertise in the line of business you’re considering. Do some five-year realistic projections. Talk to folks in the same business. What makes you think you will succeed if they have not? If you do extensive homework, you’ll be able to make an educated leap.
Consider this: if the property you purchased is “listed” property (cars, airplanes, computers, boats, until recently, cell phones(1)), and the business usage drops below 50%, you’re subject to recapture (that accelerated depreciation you took) at ordinary income rates right then and there, no waiting until that equipment is sold. Furthermore, your depreciation from that point forward must be calculated using the (slower) straight-line method.
Consider this possibility as well: say your accelerated depreciation deduction threw you into a lower tax bracket, but a year or two down the road, you’re back in the highest bracket (partially caused by the low depreciation expense you now have). Voila. Your recapture will be paid at higher tax rates than the tax rate you took the deduction/savings on a few years back. Did that salesman tell you that?
If you have an overwhelming need to divest yourself of some cash to obtain a tax write off, rather than buy unneeded equipment, why not consider giving to a charity? You get the same deduction, you won’t be paying property tax on a piece of equipment as long as you own it, or making loan payments or paying for repairs on same-said equipment. You win, the charity wins.
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Footnotes:
(1) The Small Business Job Creation and Access to Capital Act of 2010 removed cell phones from the definition of listed property. The Act also increased the maximum deduction for qualified Section 179 property to $500,000 and the investment limit to $2,000,000 for tax years beginning in 2010 and 2011.
(2) The Tax Relief Act of 2010 increased the bonus depreciation to 100% from 50% for the period September 9, 2010 through December 31, 2011. The bonus reverts to 50% for 2012.
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