Bonus Depreciation, 1031 Like-Kind Exchange or Both?

Steve Doherty's picture

"Should I take (or wait for) bonus depreciation or should I utilize a 1031 like-kind exchange strategy?" Business owners have asked themselves this question since the passage of the Job Creation and Worker Assistance Act of 2002. Bonus depreciation of 30%-50% - and even 100% - has been a part of our tax landscape for over 12 years, and while the jury is still out on whether it has a stimulus effect on the economy, there is no question that its availability has enabled business owners to forestall paying taxes.

Tax Strategies

Reduction or postponement of tax payment is a driving force behind any tax strategy. bonus depreciation achieves this goal as does the use of a 1031 like-kind exchange. A question we are frequently asked is, “What if bonus depreciation gets extended? Wouldn't money invested in implementing a 1031 like-kind exchange program be wasted?” Perhaps not.

Granted, bonus depreciation will enable you, via a dramatically accelerated depreciation schedule, to reduce or eliminate taxes this year, but it’s a double-edged sword because bonus depreciation has always been a temporary measure for economic stimulus, not a permanent addition to the tax code. At some point, when bonus depreciation expires, equipment owners will be in possession of used equipment with little or no basis, the sale revenue of which will be fully taxable.

Consider instead the combination of bonus depreciation and a 1031 like-kind exchange program.  This would allow business owners to:

  • Dig the Net Operating Loss (NOL) well deeper, stacking up a deductible expense that can carry forward several years.
  • In the event rates are reduced, pay back their deferral with cheaper dollars, should they stop their 1031 exchange program
  • Offset other income streams when the economy grows stronger and business is prospering. Many companies who were in bonus depreciation-driven NOL’s now have enough other taxable revenue to warrant using both.

A Side-by-Side Comparison

Consider the following example of a company selling off 100 used trucks per year, fully depreciated, for $45,000 per truck and a 40% blended state-federal tax rate. The following charts depict a five-year cash benefit snapshot (Millions). Notice that the $2.7 million cash benefit number does not change - only the timing of its distribution based on the inclusion or absence of bonus depreciation in 2015:

 

As you can see from this example, Bonus Deprecation does not impact the overall cash benefit, merely its timing. The inclusion of the 1031 like-kind exchange component ensures the cash benefit of $2.7 million.

Summary

A benefit analysis of a possible like-kind exchange program should consider the impact of ongoing bonus depreciation as well as foregone depreciation (the reduced basis on new replacement property purchased with like-kind exchange eligible funds). Confer with your tax advisor to accurately project what your cash position/benefit would be with and without the adoption of a 1031 like-kind exchange program.

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