Issue link: http://read.dmtmag.com/i/134956
On the Numbers Dual Use Update AED is working with the IRS on your behalf to define parameters for sale of rental units. By Garry bartecki As mentioned in previous columns, AED is working to respond to the IRS's invitation to submit comments about tax accounting for dual use transactions. Our industry and the IRS are hoping to develop an industry standard or bright-line test to determine if specific types of rental transactions or groups of transactions are eligible for both tax depreciation and LKE. In simple terms, the IRS has an issue with our industry when an inventory unit is sold as part of a rent-to-own transaction, or is just sold out of a rental fleet after being in the rental fleet a short time. In my mind, if a unit is sold within the fiscal year both the rentals and final sale proceeds would fall in the same year and the appropriate taxable income recognized. And even if the transaction straddles a year-end there are ways to account for the transaction so as not to be penalized in any one year. Where we get into a problem is with a short-term rental that converts to a sale with the dealer using LKE to spread the tax gain over a fiveyear period, which reduces taxable income in the transaction year and reverses itself through reduced depreciation deductions over the next five years. LKE is 100 percent available when business assets (rental asset) are sold. No doubt about it. Set LKE up right and stick to the strict compliance rules and you should have no problems under audit. The problem lies in defining a sale of inventory versus the sale of a business asset – remember, LKE is not available for the sale of inventory. Consequently, the IRS needs to be convinced that your transaction was not the sale of inventory but the sale of a rental asset, and so far they're apparently not very convinced. They believe a dealer is in the business to primarily sell inventory and that maybe certain inventory sales are merely disguised as "rental" transactions. To reach a conclusion one way or the other the IRS looks primarily at three issues: n How long the unit was in the rental fleet before sale n How many times it was rented to different lessees n What percentage of the cost is recovered through the sale My personal opinion is that cost recovery is the major point of consideration, because if a rental unit is put to use as a rental its orderly liquidation value or retail value is diminished by the hours put on the unit in the field. So if you rent a unit and then sell if for original cost you are going to have a problem that is hard to defend. On the other hand, if you rent the unit and sell it for 70 percent of original cost you can demonstrate a reduced value resulting from the rental activity. Back in 2002, the IRS issued a TAM that suggested a few things along these lines: n 70 percent of the rental pool in question was rented at least one time, with the remaining units not yet placed in the dirt. n The units were rented at least five times to different parties and remained in the fleet for 18-24 months. n The units were sold for 68-81 percent of original cost. These certainly sound like rental transactions to me. The deadline to respond to the IRS is June 16, but AED and its allies are petitioning for an extension to give us more time to gather data. To help the IRS understand how a dealer operates today – blending sales, rentals, and sales of rental units as needed – AED will be conducting a survey to determine how you handle RPO transactions, how long rental units remain in the fleet before they are sold, and at what percentage of cost they are sold for. We are going to get pretty specific and probably work along the line of those classes of equipment represented in the Rouse Reports. We will use your input and work with the IRS to set standards for: n How long a unit must be in the rental fleet to be considered a rental unit n How many times it needs to be rented to different customers (not a big issue in my mind) n Determine an appropriate percentage of cost that demonstrates the equipment lost value as a result of rental hours in the field If we get this resolved all dealers will have the opportunity to depreciate their rental assets and use LKE if they choose. If you hope to retain your current method to account for RPO transactions, make it a point to respond to our survey. Garry bartecki (gbartecki@ aednet.org) is AED's vice president of Finance. June 2013 | Construction Equipment Distribution | www.cedmag.com | 45 45_On_the_Numbers_KP.indd 45 5/31/13 1:04 PM