Crunching Numbers

When President Bush signed the Economic Stimulus Package into law on Feb. 13, 2008, it made headline news across the country. Americans watching the nightly news rejoiced at the prospect of receiving a bonus check from Uncle Sam. Included within those reports was reason for demolition contractors to celebrate too, especially because their unexpected reward would be much more substantial.

The legislation contains two particular provisions that could provide purchasers of demolition equipment with more than $100,000 in tax deductions in 2008, according to a report from the Association for Manufacturing Technology. Consequently, it is causing demolition contractors to carefully consider possible benefits from expenses associated with renting or purchasing new excavators and attachments.

With the enactment of the stimulus package, the incentive to buy new excavators has increased dramatically. However even with the added potential deductions, some demolition contractors may realize more cost-effective solutions through renting or entering rental purchase options.

YWhen the government introduced the stimulus package earlier this year, lawmakers emphasized the need to stimulate economic activity in both large and small businesses. "Giving them an incentive to invest now will encourage business owners to expand their operations, create new jobs and inject new energy into our economy in the process," Bush said about the stimulus package. With this goal in mind, two clauses regarding tax deductions for equipment purchases were included in the legislation to immediately affect business spending.

The first benefit of the new stimulus package for demolition contractors is a one-year, 50-percent bonus depreciation clause for purchases of brand new equipment.

Typically a new excavator would depreciate at a 14 percent rate over the course of seven years. However, contractors purchasing a new excavator and putting it to use between Dec. 31, 2007 and Jan. 1, 2009, will be able to depreciate the cost of the excavator at 50 percent for 2008, according to Liz Nicolson, government relations director for the Association For Manufacturing Technology (AMT). Additionally, buyers will be able to depreciate the normal 14 percent rate off the remaining cost after deducting the 50 percent, she adds.

An AMT news release offers this example to explain the tax deduction benefits. Under the old law, a contractor would be able to depreciate 14 percent on a purchase of a $100,000 excavator, or $14,000. However, if purchasing and putting it to use in 2008, a company can depreciate 50 percent of the purchase price when filing taxes, or $50,000. In addition, they can depreciate the normal 14 percent from the remaining $50,000, or $7,000. In total, the contractor could claim $57,000 (57 percent) of the cost of the excavator as a 2008 deduction off the year’s taxable profits.

While the 50-percent bonus depreciation does not actually put more money in demolition contractors’ pockets over the long haul, it significantly speeds up the depreciation process. "Taking advantage of this accelerated depreciation may help struggling businesses balance their books for this year, while also attaining needed assets," says Nicolson.

The second clause included in the stimulus package is especially beneficial for smaller contractors. Under the previous Tax Code Section 179, businesses could write off up to $128,000 from year end taxes for new or used equipment purchased and placed in service during a given year, as long as they did not spend more than $510,000 on equipment in that given year, according to the Internal Revenue Service’s (IRS) Web site.

However, because of the stimulus package, this year businesses can write off up to $250,000 from year end taxes for new or used equipment purchased and placed in service during 2008, as long as they do not spend more than $800,000 on equipment during the year. If a business’s equipment expenses exceed $800,000, it can still take advantage of Section 179, but only after decreasing the amount it can write off by one dollar for every dollar exceeding $800,000, according to the IRS Web site.

Contrary to the bonus depreciation, the revised Section 179 can increase the long-term profits of demolition contractors because it does not accelerate deductions, but actually creates an increase of $122,000 in possible deductions. Perhaps the best news for qualifying contractors of the revised Section 179 is that even if their equipment expenses exceed the $250,000 allowed as a deduction, they can still apply the aforementioned 50-percent bonus depreciation to the remaining costs.

"The whole thing is designed to encourage businesses to not only buy machines this year, but also to reduce their costs," says Bret Jacobson, product manager, earthmoving excavators for Liebherr, Newport News, Va.

And it’s working. Jacobson says that as a result of the tax incentive, Liebherr is experiencing a better second half of the year as contractors are taking advantage of the tax deductions before they expire.

"We have orders right now contingent on being able to deliver this year for customers to be able to take advantage of the economic stimulus program," Jacobson says.

Neil LeBlanc, senior marketing consultant for Caterpillar Inc., Peoria, Ill., also reports his company’s order board being full.

It appears government’s intention to stimulate businesses has resulted in a win-win situation for both demolition contractors and manufacturers. Contractors are taking advantage of the taxation benefits and manufacturers are experiencing increasing sales.

After looking at the added benefits of purchasing an excavator in 2008, it may be hard to believe that some contractors would still be smarter to rent.

However, regardless of the tax deductions available when buying an excavator, purchasing only makes sense if contractors can get enough value out of it to justify the cost, and there are times they cannot.

When considering whether to buy an excavator, contractors should examine four key factors: utilization, complementation, work levels and financial considerations, says Mark Ramun, director of demolition and recycling for Kuhn Equipment, Summerville, S.C. Utilization encompasses how useful the excavator or attachments can be for a contractor over time. "Highly specialized pieces of equipment may not always be necessary," Ramun says. "This may present a good case for rental rather than ownership."

Additional consideration needs to be given to how well the excavator complements a company’s existing inventory. According to Ramun, it may be a quality piece of equipment, but if it isn’t compatible with the brand of other tools in a fleet, or if it requires extensive support not available in the contractor’s region, buying it would just be adding a "misfit."

The most unpredictable aspects concerning whether to rent or buy are present and anticipated work levels. Given the fluid nature of the demolition industry, predicting future work levels requires contractors to plan and conduct market research and can save money in the long run, according to LeBlanc. "If long-term workloads are not consistently strong, renting equipment is the most cost-effective solution," LeBlanc says.

Finally, excavator and attachment rentals also contain tax implications for contractors to consider. While added tax incentives may make the purchasing market look increasingly lucrative right now, if a contractor cannot justify buying the machine, the rental tax deductions are even more beneficial.

"Renting equipment is expensible, so they can write 100 percent of rental costs as a cost of completing a project," Ramun says. "Whereas when they own the excavator they have to depreciate it and cannot write it all off at once."

Because of the rental tax deductions, contractors can still be winners at the tax game even if they can’t find justification for purchasing an excavator.

Luckily for contractors still struggling with the decision of whether to rent or buy excavators and their attachments, there is an attractive alternative. Rental purchase options (RPOs) provide contractors all the benefits of renting with the added incentive of potential ownership. Typically, RPOs are negotiated over a three to six month time period, where they serve as an equipment trial while also offering some protection against losing value on money poured into excavator rental costs.

"If the contractor’s workload increases or his desire to purchase that specific machine grows, it will often make financial sense to convert the rental into a purchase," says LeBlanc.

Most RPOs apply 100 percent of the rent toward the purchase price for the first month, with a lower percentage being applied in subsequent months. However even if only a portion of the rent is applied toward buying, contractors can maximize their value while minimizing their risk. RPOs allow contractors to enjoy freedom from guaranteed monthly payments should their work levels slow down, while also allowing them to try equipment they may be unfamiliar with.

"This allows the contractor to build ‘equity’ in the rental package and capture the equipment at a later date," says Michael Camp, vice president of sales and marketing for Gibson Machinery LLC, Oakwood Village, Ohio.

Further benefits of RPOs are seen as contractors consider tax deductions, especially in 2008. As with rentals, when entering an RPO, 100 percent of the monthly payment can be written off when filing taxes, providing contractors added incentive to enter an RPO even if they are certain they will eventually buy the equipment.

For example, a contractor who is certain he will purchase an excavator agrees to a three month RPO with 100 percent of $50,000 monthly payments being applied toward the purchase price of $300,000. After the three months the contractor would only owe $150,000 to cover the remaining balance. Only that amount would be subject to sales tax, with the other $150,000 paid in rental fees being 100 percent deductible when filing taxes.

In 2008 there is even more incentive because that $150,000 purchase price is subject to the 50 percent depreciation clause, for new equipment, and the revised Section 179 for qualifying businesses, for both new and used equipment. Additionally, RPOs can save contractors money when applying for a loan to cover the balance of the excavator, says Jacobson.

"If you have an agreement where you’re going to pay rent and then have a lower purchase price," Jacobson explains, "at the end of the whole thing, you’re more likely to get approved for a smaller amount and then you end up paying much less in interest over time."

Because of the substantial amount of money that can be saved in taxes and financing, contractors who know they will eventually purchase an excavator negotiate the highest possible rental payment during RPOs, to minimize the amount of sales tax they will ultimately pay on the purchase and increase the tax amount they can write off from renting equipment.

Jacobson says Liebherr is experiencing an increase in RPOs from contractors who are privy to the significant tax benefits. "We are seeing people that wouldn’t ordinarily purchase an excavator, but they are doing an RPO so they can build some equity in the machine and convert the machine into a purchase toward the end of the year to take immediate advantage of the tax incentive," Jacobson says.

Perhaps the best part of RPOs is that monthly payments are typically the same whether entering an RPO or a normal rental agreement. As Ramun says, "There is no risk, only added incentive."

No matter what method of finance they choose, contractors looking to add an excavator to their fleet in 2008 find they have a great deal to gain in taking advantage of the year’s numerous tax incentives. C&DR