Year-End Tax Planning for Contractors: Take Advantage of These Depreciation-Related Tax Breaks

With a few months left to go in 2016, it’s a good time for contractors to consider their tax situations for the year and to take steps that may help reduce their prospective tax liability. Notably, the passage of the Protecting Americans from Tax Hikes (PATH) Act of 2015 extended or made permanent a number of breaks with the potential to provide significant savings.

Several provisions of the PATH Act pertain to depreciation-related tax breaks. You probably read about these every year. The good news is that, thanks to the legislation, they’re still going strong.

Section 179 expensing

Section 179 of the Internal Revenue Code allows businesses to “expense” the cost of certain tangible property acquired and put into service during the tax year. This means that you can deduct the cost immediately, instead of through depreciation deductions over time.

The amount that can be deducted is subject to certain limits: Right now, a business can expense up to $500,000 in qualified new or used assets, but with a dollar-for-dollar phaseout once the taxpayer hits and exceeds $2 million in asset acquisitions. Without the PATH Act, the expensing limit and phaseout would have reverted to $25,000 and $200,000, respectively. Be aware that you can use Sec. 179 expensing only to offset net income; you can’t use it to reduce income below $0 to create a net loss.

If you’re anticipating the purchase of new or used construction equipment in the near future, you may want to buy it before year end so you can expense the cost under Sec. 179. On the other hand, if you’re already at or near the allowable ceiling, you might be better off waiting until January to buy the asset(s) so you can take the deduction for the 2017 tax year.

The PATH Act made permanent the ability to apply Sec. 179 expensing to qualified real property. It also permanently included off-the-shelf computer software on the list of qualified property and, as of 2016, added heating and air-conditioning units to the list. Here again, as the year winds down, consider your tax liabilities and how the timing of such acquisitions might affect your bottom line.

Bonus depreciation

Along with addressing Sec. 179 expensing, the PATH Act affects bonus depreciation. This tax break allows businesses to recover the cost of depreciable assets faster by deducting an extra share of depreciation during the first year they’re placed in service. Note that bonus depreciation applies only to qualified new tangible assets with a recovery period of 20 years or less. Examples include office furniture and equipment, and off-the-shelf computer software.

The bonus depreciation provision has been extended, only through 2019, and with diminishing allowances after 2017. Allowable bonus depreciation remains at 50% for this year and next, and then drops to 40% in 2018 and 30% for 2019.

Interestingly, the PATH provision allows businesses to claim unused alternative minimum tax (AMT) credits in place of bonus depreciation. The amount of unused AMT credits that can be claimed increases in 2016.

Which way to go

Bear in mind: Within the allowable limits, you can recover the cost of qualified assets using Sec. 179 expensing or bonus depreciation. You can’t claim the same asset under both breaks. So which is better?

Sec. 179 expensing may yield higher benefits because it allows you to claim 100% of an asset’s cost, whether the item is new or used. On the other hand, bonus depreciation may be the better strategy, because it isn’t subject to asset purchase limits or net income requirements.

Best course of action

We’ve covered some of the key points of depreciation-related tax breaks, but it’s a good idea to discuss this topic in depth with your CPA. He or she can assess your construction company’s specific tax situation and asset needs and recommend the best course of action.

Claiming the research credit

It’s great to claim a tax break for depreciation — but how about innovation? Many contractors overlook the research credit (often referred to as the “research and development,” “R&D” or “research and experimentation” credit).

Designed to stimulate technological innovation, this tax break doesn’t require a company to develop a patentable invention. Rather, it rewards a product, process, technique, formula, computer program or invention that improves some function or performance. So your construction company may qualify if it’s taken steps and incurred costs to:

• Solve site-specific problems on a project,
• Propose an innovative way to improve the constructability of an architect’s design, or
• Implement an experimental training and evaluation method for your employees.

Any new or improved design or process may qualify for the research credit. To determine whether it’s worth pursuing, you’ll need to undertake a study to calculate your construction company’s R&D expenses in not only the current year, but also previous years. You’ll need to consider alternative minimum tax issues related to the credit, too.

The PATH Act reinstated the research credit retroactive to January 1, 2015. In addition, in 2014, the IRS instituted new rules simplifying the process of filing for the credit, while also making it possible to file amended returns to qualify retroactively in previous tax years.

For additional year-end tax planning tips and other Construction Industry Services, please contact Sabre Linahan, CPA, at 404-874-6244 or leave us a message below.