Two Huge Tax Breaks for Business Buyers
The Tax Cuts and Jobs Act (TCJA), signed into law nearly a year ago on December 22, 2017, transformed the corporate tax code. In particular, it significantly changed the way that small businesses depreciate assets by expanding both Section 179 deductions and first-year bonus depreciation. With these two methods, businesses can elect to write off the entire purchase price of “qualified” assets, rather than recover it through a longer depreciation schedule.
Many business owners are aware that they can take advantage of these deductions to purchase assets for their current business. But these same tax benefits can be applied to the purchase of a business as well, whether you’re entering a new business or growing your current business through acquisition.
That’s right! These incentives are in place to encourage businesses to acquire new assets to grow their businesses—it doesn’t matter if those assets come directly from a manufacturer or are bought from another business. So long as the deal is structured as an asset purchase, a significant portion of the purchase price could be eligible for a Section 179 deduction and even bonus depreciation!
But you have to understand what the rules say and how they apply to your deal. So, let’s look a little more closely at how the TCJA changed Section 179 deductions and bonus depreciation and how these cost recovery systems can benefit a business buyer.
Pre-TCJA Section 179 and Bonus Depreciation
Section 179 is a section in the tax code that allows businesses to deduct purchases of qualified assets that have been placed in service in a given tax year. The section itself is not new, and many business owners have recognized the benefits of Section 179 deductions in the past.
Under pre-TCJA law businesses were allowed to make Section 179 deductions, but these deductions were limited to $500,000. The assets could be both new and used equipment, including “off-the-shelf” software.
Bonus depreciation (Section 168(k) of the tax code), on the other hand, deals with equipment purchases in excess of the Section 179 expense cap. Prior to the TCJA, bonus depreciation was limited to 50% of the cost of qualifying equipment, and the equipment had to be new equipment.
Post-TCJA Section 179
Thanks to the TCJA, the allowable Section 179 deduction has been increased to $1 million for qualified assets acquired beginning in 2018 and beyond. Not only that, but the maximum spending phase out (the amount your company can spend before you aren’t allowed to take the deduction) has also been increased from $2 million to $2.5 million.
Additionally, the TCJA permits qualified assets to include certain tangible personal property and some improvements to nonresidential real property (e.g. roofs, HVAC, fire protection systems, and security and alarm systems) to be used for a Section 179 deduction.
Post-TCJA Bonus Depreciation
However, the most radical changes were made to bonus depreciation. The TCJA increased the first-year depreciation deduction to 100% for qualified assets acquired and placed in service after September 27, 2017. It also removed the requirement that the qualified assets be brand-new; instead, property can be “new-to-you” and still qualify for 100% bonus depreciation.
Unfortunately, the 100% bonus depreciation won’t be available forever. The percentage will phase out beginning in 2023, dropping 20% each year through 2026.
Huge Implications for Buying a Business!
Section 179 deductions and bonus deprecation aren’t just great incentives for business owners looking to grow their businesses. They can also be hugely advantageous to anyone looking to buy a business as a way to recover some of the cost of the investment.
The increase in the Section 179 deduction cap to $1 million gives business buyers more freedom to control the tax burden associated with a business purchase.
But most important is the elimination of the “original-use” requirement for bonus depreciation. In pre-TCJA business purchases, the “original-use” requirement meant that any assets purchased in a business acquisition were ineligible for bonus depreciation because they were previously used.
Now, though, qualifying “used” property purchased in a business acquisition available for the 100% bonus depreciation deduction. So long as the qualifying asset is “new-to-you,” 100% bonus depreciation is an option.
It is important to note that the buyer doesn’t have to pay the full purchase price in the first year for the qualified assets to be eligible for the Section 179 deduction and bonus depreciation.
At the end of the day, these tax incentives mean that the buyer’s ability to deduct a larger portion of the purchase price (potentially even more than the actual price!) will make the transaction much less expensive and create a tax-free source of cash to buy. Given the right circumstances, knowing that she can recover a larger chunk of the cost gives the buyer more room to negotiate on purchase price and makes the transaction more attractive overall.
Asset Deals and Allocation of Purchase Price
These benefits, however, are dependent on the structure of the deal. Bonus depreciation and Section 179 deductions are usually available to the buyer only when the acquisition is completed through an asset purchase.
With a stock sale, the owners of the assets—the corporation—doesn’t change, and the tax arrangements remain the same as they were before the sale. (Proposed regulations have recently been issued by the IRS concerning the so-called Section 338(h)(10) elections and Section 336(e) elections whereby, under very specific circumstances, stock purchases can be treated as asset purchases for tax purposes and so qualify for bonus depreciation. Since the regulations are not final yet, it’s best to leave this topic for another time.)
This means that if you’re thinking about purchasing a business, you must make tax considerations part of the offer strategy. You should consider the tax treatment or benefit a cost of the transaction and plan for it ahead of time. In fact, given this new business landscape, the tax considerations of a business purchase can ultimately make or break your business deal.
So, the deal structure and allocation of the purchase price are going to determine what the buyer can immediately depreciate or deduct and how much he can reduce his taxable income in the year of purchase as a result.
Of course, the seller may also know that these tax incentives exist, and, hoping to indirectly reap some of these benefits, may insist on a higher purchase price for the business.
Why Is Now the Time?
If you’ve been considering buying a business, now is certainly the time to make your move. The TCJA offers business buyers two critical ways to realize extra economic savings on the transaction cost:
- $1 million Section 179 deduction cap,
- 100% bonus depreciation on both new and used qualified property.
Again, together with your tax advisor and your business attorney care must be taken to plan ahead regarding the structure of the purchase and the allocation of the purchase price. But with proper planning, you can significantly benefit from the changes to the tax code and reduce the cost the acquiring a business by recovering more of the purchase price over a shorter period of time.
How Can We Help You?
Here at Alexander Abramson, we focus exclusively on business-related legal matters. Our attorneys have advised closely held businesses and business professionals on everything from partnership arrangements and business contract matters, to raising equity capital, to buying or selling a business.
Ed Alexander is also a Florida licensed business broker and a shareholder of Fitzgibbon Alexander, Inc., a Central Florida consulting, business valuation, and business brokerage firm.
Our staff strives to create a wonderful client-experience by actively listening and maintaining open lines of communication, consistently meeting deadlines, and being upfront about our pricing and services. Don’t trust the legal needs of your business to an attorney that can’t or won’t offer you the best service possible.
We would love to speak with you directly about how we can help you buy a business. Call us 407-649-7777 or…
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