By Marcus Renwick and Dr. Bart Basi
Business owners are constantly faced with decisions of all kinds. Being a business owner not only entitles you to make decisions, but also mandates that you do so. Most decisions are based solely on instinct and business sense. However, decisions with tax consequences, such as the following, require a bit more knowledge to make the right choice:
The Rent or Buy Decision: Most business owners face this decision at least once every year, whether it's deciding whether to rent or buy a building, large equipment, or a vehicle.
- Rent for a business is generally deductible as it is paid or as it becomes due, as long as it is an expense that is ordinary and necessary (reasonably related to your business).
- Purchasing an asset, on the other hand, does not always allow the purchaser to deduct the expenses immediately, as they can with rent. When purchasing an asset, the cost of the asset is depreciated over a period of years--not as the asset is paid for, but as the asset is used in the business.
However, the tax laws further complicate the decision: Purchase of equipment might be fully deductible under section 179 of the tax code. Under this section, equipment purchased for up to $102,000 can generally be written off in the year purchased. Be aware of the principles, but it's a good idea to talk to a tax consultant before deciding to rent or buy.
The Maintain or Buy New Decision: When a machine goes down, the business owner must either repair or replace the equipment.
- Repair expenses that merely extend the life of an asset are generally deductible as they are paid, so in most cases, the business owner will see a more immediate tax benefit for the money spent.
- Replacement equipment (assuming it is purchased) is depreciated over a period of years. Through 2005, the tax code allows for a special deduction (section 179) on equipment purchases of up to $102,000. If you purchase a depreciable asset for up to $102,000 in value, you can generally deduct that asset in the current year.
Generally, it is better tax and financial advice to repair an asset that is in good condition as opposed to replacing it. However, knowing when to replace old equipment is an art that requires careful consideration of the tax aspects.
Sell or Trade In: If you decide to purchase a new asset, what are you going to do with the old one? Generally you will get more money for the sale of an asset as opposed to trading it in to a dealer.
However, from a tax perspective, it may be much smarter to trade in the asset. As expressed above, disposition of an asset that has been depreciated leads to a higher tax rate. Both ordinary and capital gains taxes must be paid on the sale of the asset.
Under the tax code, vehicle trade-ins generally are not subject to ordinary tax or any capital gains tax. This is because trade-ins are generally treated as like-kind-exchanges, which can substantially lower your tax burden as opposed to selling old equipment outright. So think twice before selling the old equipment. You'll do much better by trading it in when you buy its replacement.
While common sense may not seem applicable to the tax code, it certainly helps when you're making decisions about your business. Just because the tax angle calls for a sale as opposed to a trade-in (or vice versa), don’t deny common sense. Get the facts about how your decision will affect your company's taxes, and go from there.
Attorney Marcus Renwick has worked at The Center for Financial, Legal and Tax Planning Inc doing research, writing, IRS dispute resolution and client advisement.
Dr. Bart Basi, attorney, CPA and founder of the Center, specializes in financial and legal matters, particularly for closely held and/or family businesses. Both can be reached at the Center for Financial, Legal and Tax Planning Inc., 108 E. DeYoung St., Marion, IL 62959, 618/997-3436.
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