Class Lives under Tax Reform

IMGCAP(1)]While the tax code definition of useful life for business assets is intended to correspond to their actual life, this isn’t always the case.

As a result, businesses holding certain assets are able to recoup the entire cost of acquiring the asset long before it’s ceased to produce value, according to Dean Sonderegger, executive director of product management, software segment, at Bloomberg BNA.

“Existing asset class lives can sometimes lead to a rapid tax write-off of the value of the asset purchased,” he said. “For example, companies purchasing corporate jets are able to deduct two-thirds of the value of the jet’s purchase within three years of purchase of the jets.”

A jet, however, can reasonably be expected to continue to function for well beyond five years, possibly even for decades.

“It’s not as though you’re buying a jet and it pays for itself, but you do get quite a good tax break when you purchase it because the recovery life of the jet is so short compared to its actual useful life,” said Sonderegger.

“These rules were put in place originally in 1986 with the last comprehensive tax reform,” said Sonderegger. “Railroad cars are another example. They have a seven-year tax life, but they can last for 30 years or more, so you get an accelerated write off for tax, compared to GAAP depreciation.”

“Moreover, if you think about the time value of money, a deduction you can get today is worth more than one that you take 20 years from now,” he noted. “If I’ve written off the cost within five years, I’ve taken a deduction for the entire value. Assume I write it off over 20 years for financial accounting purposes. It means I had a lower tax rate in the first five years after the purchase, but a higher rate in the last 15 years because I’ve already taken the tax deductions for the asset.”

The great debate that we have now is whether and to what extent depreciation affects buying decisions, according to Sonderegger. 

“Accelerated depreciation is even more noticeable with bonus depreciation, which expired in 2013 but is currently under consideration for two more years as one of the tax extenders,” he said. “The idea was that if you get a certain percent of the value immediately as a tax deduction, there would be an incentive to make purchases of capital assets. But CRS [Congressional Research Service] analysis concluded that there is no stimulus effect. People are making decisions independently of the tax treatment.”

Any of the tax reform proposals that have been recently floated would weaken accelerated depreciation, according to Sonderegger. “What will happen is that the classes themselves won’t exist, or the classes will exist but the useful lives will get extended.” 

However, proposals currently on the table would continue to include some form of the Section 179 expensing deduction, observed Sonderegger. “It’s meant to be a stimulus for smaller businesses. Instead of tracking assets and depreciation over time, they simply take the dollar amount and write it off immediately. It will probably continue to be part of any tax regime for fixed assets moving forward.”

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