Year-end equipment buys fit the bill - Up front/out of pocket

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Year-end equipment buys fit the bill
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To claim bonus depreciation, property must be (1) eligible for basic depreciation (the modified accelerated cost recovery system or MACRS, with a depreciation period of 20 years or less); (2) computer software (off the shelf); or (3) qualified leasehold property. The property must be purchased and placed in service during 2008.

Borrow or lease
Will the new equipment be purchased with borrowed funds? Or would it be more advantageous for the woodworking operation to lease? Leasing might mean losing the tax benefits of first-year Section 179 write-offs as well as the 50 percent bonus depreciation allowance. Instead, the woodworking business gets an immediate tax deduction for all lease payments. Also remember that, under some circumstances and with certain types of equipment, the full amount of the equipment purchase may be deducted in the first year.

The cost-reducing tax advantages under either the financing or the leasing option depend heavily on the situations of both the woodworking business and its owner. By no means, however, should the decision be based solely on the first-year, out-of-pocket outlays.

Whether the woodworking operation will benefit from newly acquired equipment at year’s end — or whether it will have the profits to take full advantage of year-end tax breaks and afford the out-of-pocket expenditures necessary to buy or lease that equipment — will only become apparent as the end of the tax year approaches.

Up front/out of pocket
With a loan, a typical down payment is usually required. Most lenders ask for at least 10 percent or more of the purchase price as a down payment, although some lenders may require more. However, when planning a year-end equipment acquisition via the purchase route why not investigate seller-provided financing?

A large institutional lender is financing those purchases based on the woodworking business’s financial history and prospects. Should the operation fail to repay the borrowed funds, the financial institution would, of course, take possession of the equipment. But what would it do with the repossessed equipment and at what price?

Dealer, manufacturer or seller financing might, in some cases, be more expensive, but the up-front money is usually less. After all, should an equipment buyer default, the seller is in an excellent position to resell the repossessed equipment and can accomplish this far more efficiently, and at a lower cost, than a financial institution.

Acquiring equipment under a lease arrangement also involves certain up-front costs. The first and last lease payments might, for example, be required to enter into the lease. Although in some cases it may be possible to enter into a lease arrangement without an up-front payment, generally any advance payments required on a lease are less than a comparable loan down payment.

Particularly important today are interest rates. Although traditional loans are generally harder to obtain, interest rates are historically low. With a loan, the interest rate is the cost of borrowing money and explicitly stated in the loan agreement. With a lease, the implicit finance charge is rarely disclosed.

In fact, because of the way a lease is structured, it may be difficult to determine the interest rate. In some cases, a number of equal lease payments are due up front, plus the monthly payments over the term, plus a lump-sum payment at the end of the lease. Because the amounts of the lease payment are different, it is more difficult to determine the actual interest rate charged for a lease. But ask.

More than more
Owners of woodworking businesses operating as limited liability companies (LLCs), S corporations or partnerships may be able to utilize a Section 179 deduction, the 50 percent bonus depreciation or other tax breaks on both the business entity’s taxes and their personal taxes. It should also be remembered that many states restrict some deductions, so consulting a qualified professional is important.

Overall, however, with prices discounted to move more of the shop’s work, postponed payments to vendors and/or suppliers, stepped-up collection efforts as well as other fourth-quarter “gamesmanship” can contribute to a banner year. But just who is the woodworking business owner trying to impress? Real, long-term savings come from a reduced tax bill. And the best way to reduce that tax bill, especially in 2008, is year-end equipment acquisitions.

This year, in addition to the benefits of a full year’s depreciation with only a month or two of payments, woodworking professionals and businesses can further lower their actual tax outlays using the soon-to-expire tax breaks created by the so-called “rebate” tax law passed earlier this year.

By waiting until January (for most of us using a calendar year) you will miss the current year’s Section 179 deduction — a whopping first-year write-off of up to $250,000 in newly acquired equipment. Plus, there is also the 50 percent “bonus” deprecation deductions available for the purchases of qualifying property.

Year-end equipment purchases (or leasing) are definitely the way to go. That way, needed equipment added to the woodworking business before the end of the tax year can be rewarding.