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Tax Law Changes May Hurt Equipment Sales, Boost Rentals in 2014

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Photo courtesy of Ritchie Bros. Auctioneers
A 1031 like-kind exchange can save money by deferring taxable gains from depreciation bonuses.
Photo courtesy of Ritchie Bros. Auctioneers
Fleet owners face uncertainty in 2014 as bonus depreciation incentives expire and stringent diesel regulations take effect.
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Expiring tax perks and strict new emission rules could soon make equipment purchases pricier, spurring more rental activity and dampening new machine sales. Internal Revenue Code (IRC) 179 gives deductions for equipment purchases, including trucks and trailers, dozers and loaders, among other things.

The federal rule received a sizable boost from the Economic Stimulus Act (2008) and American Recovery and Reinvestment Act (2009) as well as subsequent legislation that renewed, extended or raised tax incentives as the economy wobbled into recovery.

"The bonus depreciation encourages capital investment during tougher economic times," says Ritchie Bros. Auctioneers CEO Peter Blake. "It's about the time value of money."

Contractors currently can deduct the full price of equipment up to $500,000 from gross income, with a $2-million limit on capital purchases, including both new and used items. There is an additional 50% bonus depreciation for new machinery. However, those perks expire on Dec. 31. Although difficult to quantify, the bonus deductions have generally aided equipment investment activity during the past few years.

"While most contractors don't check with a tax accountant before buying a piece of machinery, every purchase is being more closely scrutinized during the economic downturn," says John Crum, national construction sales manager, Wells Fargo Equipment Finance, Tempe, Ariz. "Any time you take away an incentive, there is a sales decline."

As a result, fourth-quarter sales could surge as contractors race to capitalize on evaporating bonus deductions. Equipment must be delivered in 2013 to capture IRC 179 benefits; rent-to-own options qualify if purchases are made within 90 days.

"Last year, market participants expected tax benefits to expire on Dec. 31 and were only notified of the extension after the 'fiscal cliff' resolution on Jan. 1, 2013. As a result, sales of high-horsepower tractors and other equipment reached record levels in the fourth quarter of 2012," said New York City-based J.P. Morgan analyst Ann Duignan in an investor note.

Indeed, equipment deductions may plummet to $25,000 in 2014—the same year Tier IV Final emissions take effect—spurring a possible last-minute sales boom. IRC 179 likely will have a greater impact upon smaller and mid-sized contractors with one or two items, since the deduction phases out dollar for dollar after $2 million.

No Future Bump

Future near-term tax incentives appear unlikely, given an acrimonious political climate and a stalemated Congress. Meanwhile, equipment prices are anticipated to grow in 2014 and beyond. As it stands, combined used-equipment values across 14 major rental categories increased an average of 1.6% in the first six months of 2013, reports Rouse Asset Services, Beverly Hills, Calif.

Late-model equipment is difficult to find and commands premium prices, say market observers. "Retail equipment purchases face a lot of uncertainty, with a shaky economy, expiring depreciation incentives and Tier IV Final-emissions standards," says David Schmid, president of Ecco Equipment Corp., Santa Ana, Calif. "We have to face the reality that equipment costs more today, which makes it more difficult to remain competitive."

Meeting the new federal emissions rule adds 10% to 15% to equipment costs compared to earlier model-year machines, say industry experts. Tier IV Final standards for off-highway diesel engines require particulate matter and nitrogen oxide emissions to be reduced by 90%.

A 1031 like-kind exchange program can save money by deferring taxable gains from depreciation bonuses. But a 1031 requires that sale monies go into a third-party-controlled escrow account until a substitute machine is found; replacement purchases must occur within 180 days. A 1031 enables perpetual like-kind equipment exchanges that delay taxable gains in perpetuity.

"Most people associate a 1031 exchange with real estate, but rental car companies use it for fleet renewal," says Gary A. Mott, vice president of fleet consultant FLD Inc., Delray Beach, Fla. "A 1031 defers taxable gains, and reduces federal and state income taxes for improved cash flow."

Meanwhile, rental activity has climbed amid economic and regulatory uncertainty. U.S. equipment rental revenue will reach $33.6 billion in 2013, reports the American Rental Association, which forecasts a 9.8% gain in 2014. "We already saw a shift toward renting driven by economic uncertainty, but that may accelerate when there is less advantage to buying and owning a piece of equipment," says Adam Fleck, associate research director with Morningstar.

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