The Changing Tax Landscape

Enactment of the American Taxpayer Relief Act of 2012 extended tax benefits that can make a significant difference to a construction company’s bottom line. In this still-challenging construction environment, that’s a refreshing piece of news.

The law extends 50-percent bonus (first-year) depreciation for most property placed in service before 2014. It also extends for one year the election to accelerate alternative minimum tax credits in lieu of the depreciation bonus and permits construction companies using the percentage of completion method of accounting to benefit from the capital investment incentive.

The law also extends increased Section 179 expense levels of $500,000 with a $2 million beginning-of-phase-out amount to tax years beginning in 2012 or 2013. For tax years beginning after 2013, the maximum expensing amount will drop to $25,000, and the phase-out level will drop to $200,000.

Essentially, taxpayers can elect to treat the cost of any Section 179 property placed in service during the tax year as an expense and not capitalized, allowing a deduction for the tax year in which the property is placed in service. That is particularly important to contractors, who rely on expensive equipment more than many other industries.

To qualify for the Section 179 deduction, equipment must have been purchased or leased and placed in service in taxable years 2012 or 2013. Qualifying for the deduction are vehicles with a gross vehicle weight in excess of 6,000 pounds. Other qualifying equipment includes office machines, tangible personal property used in business, computers, off-the-shelf software, office furniture and property attached to a business that is not a structural component of the building.

The law extends the rule that treats off-the-shelf software as qualifying property through 2013. Any such software that is not custom designed and is available to the general public may qualify for Section 179 expensing. To qualify for the deduction, software must be financed or purchased outright by the contractor, be used in the contractor’s business for income-producing activity, have a determinable useful life, be expected to last more than one year, be subject to a non-exclusive license and not have been substantially modified.

Qualifying software also must be designed to cause a computer to perform a specific function. A database or similar item is not considered computer software unless it is in the public domain and is incidental to the operation of otherwise qualifying software. In other words, if the core software is standardized, a small amount of customization is okay.

Equipment purchased for both business and personal use also qualifies. Typically, the deduction will be based on the percentage of time the equipment is used for business purposes.

Most of the equipment a contractor purchases, finances or leases qualifies for Section 179 expensing, regardless of whether it is new or used. Bonus depreciation, however, covers only new equipment.

Companies that lease their equipment may also take full advantage of the Section 179 deduction. In fact, leasing equipment or software with Section 179 expensing is a preferred financial strategy for many contractors because it can help with cash flow as well as profits.

With a non-tax capital lease, a contractor can acquire and write off up to $500,000 worth of equipment this year without actually spending that amount of money. Examples of non-tax capital leases include the $1 buyout lease and the 10-percent “purchase upon termination” lease. Contractors can obtain an equipment loan using an equipment finance agreement and still take the full Section 179 tax deduction.

Contractors can claim Section 179 deductions by their tax-return due date (including extensions) for the year in which they are claiming the deduction. Further, under Revenue Procedure 2008-54, contractors can amend their returns and elect Section 179 deductions without IRS consent if they did not do so for tax years beginning after 2007 through 2013.

A word of caution: Many states have chosen not to follow federal depreciation law. Bonus depreciation rules are different from state to state. Contractors who work across state lines should seek guidance from industry accountants.

Section 179 expensing rules can change each year without notice. To obtain full tax benefits from the law, contractors should meet with their accountants and tax advisers to make sure deductions are being properly claimed and reporting is accurate.