CED

September 2013

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On the Numbers LKE Gets a Black Eye, and Eyed for Cutting Grassroots effort from our industry can help lawmakers see the business necessity of like kind exchange. By Garry bartecki There is never a dull moment with these tax issues we have had on the table for the last year, and we just added a big one to the list: Working on Capitol Hill to keep Congress from eliminating LKE as part of tax reform. Just when we thought we had a positive victory for LKE, the media gave us a setback. A reporter for Forbes criticized an IRS ruling to allow taxpayers using LKE to use sales proceeds to pay down a line of credit used to finance rental units. Now, we all know in most cases a dealer or rental company would be out-of-trust if they did not pay off a sold unit on floorplan or a line of credit, or rental units funded by an installment note that are sold. You either pay down the obligation with available cash or the sales proceeds, and we all know equipment dealers do not carry sufficient balances to make such payments and still remain in business. Many dealers have told me that if they had to leave the sales proceeds with the QI they would not be able to use LKE. The IRS correctly allowed this offset when required. The reporter suggested there was a massive miscarriage of justice created by allowing the offset and that business equipment owners using this method are depriving the government of substantial tax revenue. The Forbes article comes at a time when Congress is potentially close to putting together comprehensive tax reform, so now they all hear about the IRS going soft on LKE and, lo and behold, guess what tax law is proposed for the chopping block: LKE! Needless to say, AED dealers and OEMs need to contact their congressmen to make them aware that eliminating LKE would hurt your ability to finance your business, reduce cash balances, as well as cause cutbacks on equipment purchases and, in general, decrease the value of the business. Congressmen also have to understand that LKE only provides a deferral and not a permanent tax deduction. In our case, the deferral is most likely recovered over a five-year period, with the deferral increasing and decreasing with the seasonality of the business. You get a deferral but at the same time reduce the tax basis of the replacement property, which equates to giving up tax deductions in the same amount as the deferral. At best, a dealer is deferring a cash payment for taxes at an assumed rate of 35 percent of the net deferral. The point to drive home here is the fact that in the year of the deferral your depreciation deduction is reduced for that year and another four years until the deferral is 100 percent reversed. If you sell the rental unit before the five-year tax depreciation period is up, the balance of any deferral is reversed as part of the tax gain on the sale of the unit. Again, we only have a deferral and not a permanent benefit. Debt related to the rental unit also comes into play regarding LKE. If you pay off debt on the unit being sold you must have at least that amount attached to the replacement unit being purchased. In the construction equipment world that is normally the case. Even when a line of credit is used you can pay down the line with the proceeds and draw on the line when the replacement property is purchased – normally for an amount that adds to the debt outstanding. Regarding the ruling in question, the taxpayer used one line to fund both equipment and operations, which led to the disallowance of LKE, initially. A separate line of credit for equipment may have avoided the issue in the first place. The different Bonus Depreciation rules also play a part in this story. Bonus exaggerated the deferral because in those years when 100 percent Bonus is allowed, taxpayers get a 100 percent deduction in Year 1; and when the unit is sold, the 100 percent tax gain on the sale is deferred for another five years if LKE is used. My argument here is that Congress used Bonus to accelerate investment in equipment, which it did. Eliminating LKE at this time is sure to have the opposite effect and reduce equipment purchases because higher tax burdens reduce a dealer's ability to finance equipment. Also, returning to "standard" tax depreciation policies reduce the tax benefit going forward. Please get the grassroots message out there to Congress. We need to get this train slowed down before it is too late. Garry bartecki (gbartecki@ aednet.org) is AED's vice president of Finance. September 2013 | Construction Equipment Distribution | www.cedmag.com | 47 47_On_the_Numbers_KP.indd 47 8/28/13 12:26 PM

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