In January, Congress massaged tax policy to stimulate a flaccid economy. In the resulting stimulus package are two incentives for businesses to buy new equipment in 2008. The question now is, will general contractors respond and stir the economy by upgrading their equipment fleets?
The consensus of construction industry observers seems to be that the capital investment incentives will spur more equipment purchases than otherwise might occur. However, other economic factors could well temper the response of the industry and lessen the impact of the incentives.
“There is a perception that this will have a lot of impact,” said Christian Klein, vice president of government affairs for Associated Equipment Distributors. “There really is a prophylactic benefit in preventing a major drop in construction equipment purchasing.”
Some of the faith in incentives of this kind stems from the success of a similar stimulus package passed by Congress in 2003. That legislation came after economic shockwaves struck the nation following the terrorist attacks of 2001. The legislated stimuli were credited with helping to spur the economy into the longest economic gallop in the country’s history.
“In 2003, this really had considerable impact,” Klein said during an early March interview. “It stimulated construction equipment purchases and was more than a small factor in the recovery. We are hoping we will see the same thing this time around.”
This favorable view of the earlier stimulus package is shared by Nick Yaksich, vice president of global public policy for the Association of Equipment Manufacturers.
“I think if you look at the record of stimulus packages, this helps. I think in 2003 the economy was further along in terms of being in a deeper trough and it proved very effective. I think it is encouraging.”
Yaksich noted that a survey following the 2003 legislation showed two-thirds of equipment buyers factored the incentives into their decisions to buy. At this month’s ConExpo in Las Vegas, Nev., Yaksich intended to begin surveying dealers and contractors about the new incentives.
The most publicized provisions of the current stimulus package are the $600 rebates to taxpayers, with additional givebacks per child in a household. The separate provisions of the legislation for businesses are an accelerated depreciation allowance and expanded expensing schedule.
The Two Incentives
Under the terms of the accelerated depreciation allowance, first-year depreciation of new equipment is boosted an additional 50 percent. The common illustration of the provision uses a $100,000 machine purchased and put into service in 2008. If the machine normally is depreciated for tax purposes over 20 years or less using the modified accelerated cost recovery system, the buyer in 2008 will be allowed to depreciate the machine 50 percent in the first year, or $50,000.
Under tax rules applicable to five-year property, the buyer also can depreciate it another 20 percent, or $10,000, which means the tax value of the piece of equipment becomes $100,000 minus $60,000, or just $40,000. Consequently, the tax bill on the machine is more than halved, which is money saved by the equipment owner in 2008. The remaining $40,000 is subject to regular depreciation rules in subsequent years.
The second tax incentive almost doubles expensing (deduction) limits on purchased equipment, raising the upper deduction limit to $250,000 from $128,000. The rule applies only if less than $800,000 in equipment is purchased; the expensing provision is phased out at that level. Therefore, the provision especially appeals to small businesses, whereas the depreciation allowance is beneficial to a company of any size.
The expensing provision is illustrated this way: A company buys $650,000 worth of equipment, thus coming in under the $800,000 phase-out limit. The company elects to deduct the full allowable $250,000, so that the taxable value of the equipment drops to $400,000.
Then the company applies the temporary 50 percent depreciation allowance, halving the taxable value of the equipment to $200,000. Using the five-year property rule, another 20 percent, or $40,000, of the value of the equipment can be depreciated. Thus, the $650,000 equipment is valued for tax purposes at $160,000, which is subject to regular depreciation and expensing rules in ensuing years.
A significant difference between the two provisions is that the expensing incentive applies to new and used equipment. For new equipment purchases, a company can apply both the depreciation allowance and the deduction incentive.
Another wrinkle in the tax package lets the provisions apply to rented equipment that is new when rented and is purchased by the renter within three months of the start of the rental contract. The incentives also could have some impact on the leasing of equipment, according to Wells Fargo Bank Construction Manager Ron Riecks.
“If a contractor is not going to be making enough profit to use all the incentive,” Riecks said, “let me [Wells Fargo] buy it and lease it to him and give him the benefit of that bonus depreciation through a lower lease rate than he otherwise could receive.”
Riecks said such transactions already are in the works at Wells Fargo and, presumably, other banks.
Contractors electing to use the tax incentives are reminded that accelerating depreciation allowances in 2008 will reduce depreciation offsets in subsequent years.
“People have to walk into this understanding that you can only depreciate 100 percent of a piece of equipment,” said Klein of Associated Equipment Distributors. “But I always ask business people in this situation, can you put the money to work better than Uncle Sam can?”
Klein and others interviewed about this subject each added to their observations the following caveat: Business executives should check with their tax professionals for the final word on how to proceed.
It Worked in 2003
Mike Sill, the president of RMS Road Machinery and Supplies, a Savage, Minn., heavy equipment dealership said the 2003 incentives benefited his company.
“The last stimulus package did have a positive impact,” Sill said, adding that a lot of the purchases came later in the year after contractors determined business activity warranted it.
“The last time [incentives were offered], we got a lot of activity in December that didn’t exist in previous years. The impact was measurable.”
But Sill sees a distinction between the previous economic slowdown and the current one.
“One thing that is very different this time around is that housing activity is still exceptionally low and residential construction is the primary business in a cold climate like Minnesota. A lot of guys are going to have to take a wait-and-see attitude because of housing,” he said.
Site development is not at a standstill, but some contractors will have to make do with existing inventory, Sill suspects, until they see they have “a real need” for new equipment.
“I am not expecting as significant an impact in 2008 because this key driver of the business [residential construction] is a lot softer this time.”
RMS salespeople are being tutored on the finer points of the tax package so they can help contractors make decisions about participating. Other than that, there is not much going on in Savage, Sill said, half-joking. He suggested some of his industry peers in warmer sections of the country might be seeing more movement.
“We are not a great dealer to ask. We just had the first week of temperatures above zero in a couple of months.”
In Mesa, Ariz., however, Bob Keller tells a similar story about the stimulus package: It’s too early to tell what the incentives will produce. Keller is sales manager of Bingham Equipment Company.
“We’re hoping for it to help,” Keller said. “It is sort of hard to tell yet. Even with the stimulus package most of the people we deal with are still concerned about the amount of business activity out there. It will help if the year picks up a bit, if the economy turns for the better. But if the economy stays flat…”
Keller said Bingham also benefited from the 2003 incentives, but that every situation is different.
“If a contractor needs the equipment and has the work to support it, he will go ahead and do something. But no one is going to buy equipment right now just because of the incentive package.”
Not a Complete Package
Everyone understands that the incentives are not a complete economic revival package. The Association of Equipment Manufacturers pressed Congress to go further than it did, for example, asking for additional emergency funding for infrastructure projects to give contractors more work and, hence, more reason to buy equipment.
“There have to be programs and projects. There needs to be work out there,” AEM’s Yaksich said. “What we said on the ag side was pass the farm bill. Sit down, reconcile differences and get a bill passed. On the construction side, what is needed is a long-term sustained commitment to build and rebuild our infrastructure. That is the kind of thing that is going to give contractors encouragement to make this investment in equipment.”
The AEM also is calling for approval of free trade agreements to keep the global market humming. Construction equipment exports in 2007 were up 26 percent from the year before — a total of $17.2 billion — and manufacturers don’t want that bubble to burst.
Associated Equipment Distributors is pushing for more residential construction incentives, such as a home purchase tax credit, and calling for Congress to protect the Highway Trust Fund against further erosion.
Said Klein of AED: “We recognize that contractors are rational. They aren’t going to buy equipment if there is no work.”
Riecks at Wells Fargo and others see early signs of interest in the incentives. Equipment distributors, for example, are calling the bank’s experts for training so they can explain the arcane provisions of the incentive to potential buyers of equipment.
“There are a number of things going on,” Riecks said. “There is really quite a bit of hubbub. People are still in a fact-finding mode, and one of the power tips we want to share is that the way people can make the maximum use of the incentives is to get with their accountant early in the year so they can use it to their best advantage.”
Riecks expects much of the purchasing to occur at the beginning of the work season, in the first two quarters of the year. He also expects the incentives’ impact on the economy to be greater this year than it was five years ago.
“In 2003, the stimulus package came on the heels of 9/11, which slowed down the economy fairly dramatically, in both residential and commercial,” he said. “This time, commercial work really hasn’t slowed down, so there really is a lot of work to be done for people who do infrastructure work. I believe you will see much more impact from the stimulus this time.”
The equipment manufacturer and distributor groups joined this month to print a brochure for dealers to give to customers. A sense of urgency seems to surround the stimulus package and some of it has to do with the calendar: Equipment must be bought and placed in service this year. Therefore, contractors are encouraged not to wait until the last moment to act.
Yaksich of AEM believes that extension of the stimulus is unlikely.
“I don’t think they are going to extend it. If a contractor wants to maximize his tax breaks on equipment, he has to do it now.” CEG