Depreciation: Part 3

The third primary method of depreciating new equipment purchases is MACRS. MACRS stands for Modified Accelerated Cost Recovery System. Publication 946 from the IRS goes through this and all the other types of depreciation.

MACRS uses a predetermined useful life of the equipment in question. For instance, software is 3 years and computers are 5 years. So for computers, MACRS allows for depreciating a 5 year asset over 6 years using the following percentages according to the IRS:


Year 1: 20%
Year 2: 32%
Year 3: 19%
Year 4: 11.5%
Year 5: 11.5%
Year 6: 6%

All these charts are available at the above link to Publication 946. As to whether this method is best, please consult your CPA, CFO or tax professional.

So this is more front loaded than book value, where the computers would be deducted an equal 20% each year but depreciates less in years 4 and 5. It's much less front loaded than the 179 deduction where all 100% is taken in the first year. As you can see there are lots of options and no one size fits all. These factors can be affected by leasing structures so the desire to take advantage of one of these deductions needs to be known by your leasing professional in advance.

Depreciation Part 2: Section 179

The IRS section 179 states that businesses can deduct the value of mission critical equipment directly from their income taxes in the year they put the equipment into service. This includes equipment financed through EFAs or Capital leases, as well as those paid for with cash or by bank loan. The 2008 Economic Stimulus Package increased this deduction from 128,000 up to 250,000 for the year 2008.

For instance, a business replaces $10,000 worth of computers and if they choose, the business can take advantage of the 179 deduction and deduct all 10,000 off of the current year's tax return.

The plus: if the business had an unexpectedly good year and has a taxable profit of at least 10,000 (the cost of the equipment), then its fully deductible.

The minus: if the business did tax planning all year long and didn't generate a taxable profit of 10k then they can only deduct an amount equivalent to their taxable profit, so their deduction can be limited. Also, the deduction all happens in that first year even if financed over a 3 or 5 year period.

Section 179 is a great tool for some businesses but as with most things, one size doesn't fit all. For some its a great fit and others are better off with one of the other 2 methods.

What do We Finance?

The study released in December 2007 using 2006 numbers for equipment financing shows us who finances (previous post). The study was conducted by Global Insight and entitled 'The US Equipment Finance Market Study' and the results were published in the Jan/Feb 08 issue of The Monitor.

Besides showing us who finances in the 600 billion dollar equipment finance market, the study teaches us some other things too.

What equipment types relied most heavily on financing? The # 1 type is trucks and trailers. The order:

1) Trucks and Trailers
2) Construction Equipment
3) Industrial Equipment
4) Office Equipment

While the equipment types financed are very broad, who finances is more concentrated than we thought. The top 5 states (California, Texas, NY, FL and Illinois) represented 37% of the entire US market.

The other groundbreaking piece in this study was evidence that financing is used all up and down industries and markets including being used by manufacturers in the creation of a product, distributors of that product, dealers of that product and end use customers of the product. Therefore, its use is much more accepted and mainstream than we may have thought.

Depreciation: Part 1

Depreciation is an important tax writeoff used when acquiring new equipment. For our example in this series, we are going to use a lease written for $100,000 worth of computers and software for 5 years.

The first way to depreciate is the book value method. This method allows for equal depreciation each year, in this case 1/5 of the value new, or $20,000. This means a 20k writeoff each year for the 5 years of the lease. This is the simplest method but not the most common.

Next we will look at 179 and then the MACRS.

Who Finances??

The last entry was about helping community bankers retain their business clients who they cannot approve for loans. So are the only ones that finance those that aren't 'bankable'?? In a word, No. In fact, the average financed deal is in the B to B+ paper range, the range that just borders on what banks will finance for some of their better customers. Many deals are also in the A paper range for firms that prefer to lease or just dont want the hassle that goes with providing all the financials a bank will require, since most of our deals require a credit app and credit check only.

An extensive study was done with 2006 numbers and reported in The Monitor , the equipment finance industry's top trade mag and some interesting things came out aside from the credit range info above. By company size, the most likely companies to finance, in order, are:

1) 100-1000 employees
2) 50-100 employees
3) 1-50 employees
4) >1000 employees

The surprising piece in here to me was that 1-50 employees wasn't higher. Why not? Turns out that those in this range either believe they cannot get financing or are too new (meaning at the startup stage) that think or know they cannot get financed. Financing a startup is possible, although it is more difficult to do for us than if the business is past the 2 year mark. The end result is that companies in this range often will scrounge up the funds to buy their equipment outright, a severe waste of their operating capital.

The most common equipment types to be financed are : construction and related equipment, farm equipment, transportation and industrial equipment. The fastest growing sector year over year though is technology, specifically computers and software, which are now being financed more than ever before.