Last December’s Tax Cuts and Jobs Act allowed many within the metals distribution industry to expense and immediately write off more, including a 100 percent temporary expensing deduction for adding needed equipment, vehicles, or even a new warehouse or shop building. In addition to the increased write-offs available to help offset the cost of acquiring needed business assets, changing limits on the first-year expensing rules under Section 179 further reduces out-of-pocket costs.
Writing off the cost of much of that newly acquired property in the year it is placed in service has long been possible under the Section 179 first-year expensing rules. The TCJA increased the maximum deduction for Section 179 property, while also ramping up the other major write-off, so-called “bonus” depreciation, raising it from 50 percent to 100 percent for property placed in service before 2023.
First-Year Write-Offs
The tax law’s Section 179 is an incentive designed by lawmakers to encourage businesses to buy equipment and invest in their operations. In essence, Section 179 allows a metal service center or toll processor to deduct the full purchase price of qualifying equipment and/or software purchased during the tax year. If qualifying equipment is purchased, the full cost can be deducted as an immediate expense.
Under our tax rules – and the new law – a metals distributor or processor can choose to treat the cost of any Section 179 property as an expense and deduct it in the year the property is placed in service. The new law increased the maximum amount that can be deducted from $500,000 to $1 million. The phase-out threshold, after which the Section 179 deduction is reduced, dollar-for-dollar was also increased from $2 million to $2.5 million.
The TCJA expanded the definition of Section 179 property to include improvements made to nonresidential real property after it is placed in service, such as improvements to a building’s interior. Of course, they don’t qualify if they are due to the enlargement of the building; the installation of an escalator or elevator; or the internal structural framework of the building.
Viva La Differences
Unfortunately, the new law keeps the general 39-year recovery period for nonresidential real property such as a warehouse or shop. Qualified improvements to leased property (along with restaurant and retail property improvements) are no longer separately defined nor given a special 15-year recovery period.
In the past, one of the most important differences between Section 179 first-year expensing and bonus depreciation was that both new and used equipment qualified for the Section 179 deduction. Today, however, used equipment can also qualify for bonus depreciation.
The Section 179 deduction is usually taken first, followed by the bonus depreciation. Generally, bonus depreciation is useful to very large businesses spending more than the Section 179 spending cap (currently $2.5 million) on new capital equipment. Of course, businesses of all sizes with a net loss are still allowed to deduct some of the cost of new equipment and carry the loss forward.
That Bonus Write-Off
For all property acquired by the metals service center and placed in service after Sept. 27, 2017, the TCJA requires a full 100 percent deduction of the cost of eligible new and used property, unless the operation chooses not to claim the depreciation write-off for any class of property.
While the new law eliminates the requirement the original use of the qualified property begin with the metals service center, as long as it had not previously used the acquired property and the property was not acquired from a related person or entity it will qualify. However, the 100 percent deduction phases out at a rate of 20 percent per year beginning with the 2023 tax year (and extended by one-year for certain long-production-period property and aircraft).
Paybacks Are Expensive
Although Section 179 is a write-off rather than a depreciation deduction, many distributors believe no records must be kept. The write-off is, however, comparable to claiming all of the depreciation allowed in one year. Should the business asset or property be sold or otherwise disposed of, a portion, or all, of that write-off may have to be recaptured or paid back. Obviously, the best approach is to treat all qualifying purchases like fixed asset acquisitions, retaining all documentation for at least four years after the property or assets are disposed of.
Above all, don’t forget about the property or assets being replaced. The sale of business equipment or property can generate a short-term loss. A sale that produces a gain generates ordinary income up to the recapture of depreciation after which it produces a capital gain if held long enough.
What happens when equipment, vehicles, fixtures, or other business assets or property are no longer useful to the metal service center or replaced with Section 179 or bonus depreciation acquisitions? Fortunately, many distributors and processors can claim an “abandonment” loss.
In order for the IRS to accept a bona fide abandonment write-off of any business asset there must be an actual intent, or overt act, to abandon it. Not too surprising, this two-pronged test can frequently be difficult to document.
Special Rules
Several years ago, Section 179 became known as the “SUV Tax Loophole” because so many businesses were writing-off the purchase of what were then qualifying vehicles. While that particular benefit of Section 179 has been severely reduced, special rules – and limits – remain on deductions for cars and personal-use property used in or by the business.
There are new limits on the write-off for the cost of luxury automobiles and personal-use property. For passenger automobiles and light trucks placed in service after Dec. 31, 2017, where the additional first-year depreciation deduction is not claimed, the maximum amount of allowable depreciation is increased to $10,000 for the year in which the vehicle is placed in service, $16,000 for the second year, $9,600 for the third year and $5,760 for the fourth and later years in the recovery period.
For passenger automobiles placed in service after 2018, these dollar limits are indexed for inflation. And for those eligible for bonus first-year depreciation, the TCJA retained the $8,000 limit for additional first-year depreciation for passenger automobiles. Thus, in 2018, the maximum first-year write-off is $18,000.
Similar rules apply to any property used as a means of transportation, as well as for property used for purposes of entertainment, recreation or amusement. Computers and peripheral equipment have been removed as listed property and are no longer subject to the increased substantation requirements.
When it comes to leased vehicles used by the metal service center, a deduction is permitted for the portion of the lease payment that represents business usage. If it is used 100 percent of the time for business, the full lease cost is deductible.
Let the Write-Offs Roll
Lawmakers are pretty strict when it comes to allowing deductions. The cost of starting a business, for example, can’t be deducted because there is no business. Just as there can be no business until the operation opens its doors for the first time, buying new equipment or other business assets doesn’t mean that the cost can be immediately deducted or written off. They must first be placed in service.
Determining the date property is placed in service for depreciation or other write-off purposes requires looking at factors such as the property’s assigned function and when the property is in a condition or state of readiness and available for specifically assigned functions.
Expensing is Not Always Best
Buying may not always be the best option even with the new 100 percent write-off. Expensing drops the book value or basis of the business asset to zero. If the asset is sold, any amount up to the purchase price will be ordinary, fully-taxable income.
Spreading the expense through depreciation deductions will reduce taxable income down the road when the metal service center or toll processor may be more profitable and have higher tax bills. Another time expensing may not be the most economic route is when the asset might be sold in the near future and/or the asset is one that holds its value.
The changes in the cost recovery rules are already having a significant impact on whether newly acquired equipment or business property should be depreciated or expensed and whether to choose bonus depreciation or choose not to claim bonus depreciation for any class of property. Because the new rules interact with other provisions of the law, every service center executive should seek professional advice and assistance in planning to maximize their write-offs for business property and assets.
Mark Battersby is a freelance writer and consultant on tax and financial issues based in Ardmore, Pa.