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The 2011 payroll tax cut extension came at some cost, in part funded by the end of bonus depreciation for businesses. Bonus depreciation allowed for a 100% deduction on the cost of most new capital equipment, which helps lower the income tax for those businesses. The taxes are later recouped by the government through recaptured deprecation tax upon the sale of the equipment. This cost can can be deferred when businesses that frequently make such purchases (fleet car purchases, aircraft, ships, hospital equipment, etc.) replace those items in what are called like-kind exchanges (LKEs). The tax cut will result in a sharp increase in the use of the LKE program to avoid the cost of losing the bonus depreciation benefit. For more on this continue reading the following article from Blue MauMau.

When H.R. 3765, the Temporary Payroll Tax Cut Continuation Act of 2011 was signed by President Obama on December 23rd, 100 percent bonus depreciation or the ability to quickly write off equipment purchases ended. Congress was not able to offset the expense with equivalent revenue generators.

Bonus Depreciation

Since 2010, bonus depreciation allowed businesses to write off 100 percent on the purchase price of most capital equipment effectively reducing their income tax. The government’s view is that bonus depreciation is an economic stimulus intended to increase production, jobs and corporate profits, helping businesses and individuals acquire new equipment.

The downside of bonus depreciation is the recaptured depreciation tax, due when the asset is sold, providing much needed government revenue in the form of a 25 percent recapture tax on the depreciation taken over the useful life of the equipment. Each year the equipment is used, a percentage of the equipments purchase price is deducted on the taxpayer’s federal return, offsetting federal income taxes.

With the end of 100 percent bonus depreciation, businesses who sell their equipment will experience a higher tax bill. A depreciation bonus of 50 percent remains in effect for purchases of tangible personal property with a MACRS recovery period of 20 years or less placed in service after December 31, 2011 and through December 31, 2012. In addition, new and used equipment is eligible for Section 179 expensing up to $500,000 in 2012.

Impact on Like-Kind Exchanges (LKE)

There is an alternative to paying the recaptured depreciation called like-kind exchanges (LKE), also known as 1031 tax deferred exchanges. 1031 exchanges defer the federal and state captial gains and recaptured depreciation taxes when a like-kind replacement property of equal or greater value is acquired.

Businesses that routinely sell and replace their capital assets such as dealers with rental fleets, use a LKE program or software application to track, monitor and link federal, state and local taxes across states, making the 1031 exchange a less labor intensive process. A LKE program will benefit those companies who own and routinely replace 100 or more assets. A Qualified Intermediary is required just as with a one-property 1031 exchange and an escrow account to hold the net proceeds.

The end of 100 percent bonus depreciation will result in an increase in LKE program and 1031 exchange usage. For companies that do not have 100 or more assets though routinely sell and replace equipment, 1031 exchanges can be initiated in a scaled down or “light” version of the LKE program.

Examples of LKE Equipment

Aircraft

Cars and Trucks

Construction Equipment

Agricultural Equipment

Furnaces

Ships

Railcars and Locomotives

Hospital Equipment

Technology

Forestry Equipment

Mining Equipment

Oil and Gas Equipment


The Joint Committee on Taxation
, a bipartisan committee in Washington D.C. projects the estimated value of capital gains and recaptured depreciation taxes deferred in 1031 exchanges to be $3.2 billion in 2012.