The start of a new year is an opportune time to take inventory or your business property and determine what you can do to trim the taxes owed on those assets. A handful of strategies exist to help on that front, some easier to accomplish than others.
For the most part, the personal property tax area is one that gets short shrift, says Joe Huddleston, a partner with accounting firm Grant Thornton LLP in Nashville, Tennessee. Too often, notes Huddleston, business owners overlook the tax impact of acquiring equipment and property for their businesses. "Businesses capitalize these items for federal tax purposes," he says. "Once they've done this, the equipment goes on a company's fixed-asset rolls and business owners begin to pay personal property taxes on the assets. Too often, that's the last time anyone considers them."
But regularly auditing these assets and properly classifying them can save you money. Too few business owners realize, Huddleston points out, that it's possible to trim a company's overall property tax rate by 5 to 15 percent annually if an effective tax auditing plan is put into effect.
Joan Szabo is a writer in Great Falls, Virginia, who has reported on tax issues for more than 14 years.
Unbundling Means Saving
One helpful strategy that's now gaining in popularity is known as "unbundling." Here's how it works: When you purchase new equipment, ask the vendor for an itemized bill that separates tangible costs from intangible costs. Tangible property is anything you can touch, hold or feel, says Huddleston. Intangibles relate to any copyrights, patents or trademarks included in the equipment's purchase price. In a number of jurisdictions, you're only required to pay taxes on tangible personal property.
If you've just purchased a new piece of processing machinery for $200,000, for example, make sure the vendor unbundles the purchase, itemizing all the costs. The bill would indicate the cost of the hardware was $150,000, the cost of the engineering and development portion was $25,000, and allocation to overhead was $25,000. If you're in a jurisdiction that doesn't assess taxes on the intangible costs, you'll only pay tax on $150,000, since the remaining $50,000 is considered intangible property.
To determine how your state treats tangible and intangible costs, check with your tax advisor. You may also need to seek additional help. "This is such an evolving area that a specialist who knows the current statutes and regulations on tangible and intangible property in any give jurisdiction is often necessary," says Huddleston. You can find such specialists at any big accounting firm.
Many states also provide property exemptions for software and equipment used in research and development manufacturing or pollution control. So it pays to stay abreast of these regulations as well. Your state revenue department routinely puts out notices about these types of changes.
If you recently bought equipment but were unaware of unbundling, there's good news: It's possible to unbundle equipment you already own. Ask your vendor to provide the necessary documentation, and then you may be able to apply for a refund. If you can't be bothered with the refund process, unbundle the costs anyway to lower the value of the equipment. This will help lower your taxes in future years.
When it comes to computers and other high-tech equipment, many jurisdictions have specific provisions that apply to hardware and software. In California, for example, all software is nontaxable. In Florida, embedded software is taxable; all other software is nontaxable. In Georgia, all software is taxable. Here again, it's a good idea to check with your tax advisor concerning your state's exemptions in this area.
In addition to the unbundling strategy, consider this simple checklist of dos and don'ts:
- Do a quick audit to identify assets your business is no longer using. Be sure to erase those items from your books so you don't end up paying taxes on equipment that's just sitting idle. Once you've identified your unused equipment, sell it or donate it to a charitable organization.
- Don't double-count repaired equipment. What often happens, says Huddleston, is a company may customize equipment, add to it or repair substantial pieces. When those additions and repairs are made, the old pieces need to come off your list of personal property, but too often, businesses overlook this step. As a result, they end up paying a higher personal property tax on the equipment than necessary.
- Don't assume that fully depreciated assets such as equipment are exempt from annual personal property tax assessments. As long as the assets are on your books, states will assess a tax on these items.
One way to reduce the personal property tax you have to pay on a piece of equipment that falls into this category, says Huddleston, is to have a subsidiary buy the equipment for fair market value. Then lease the equipment from the subsidiary.
- Do properly classify assets for depreciation purposes. Classifying items into specific categories, such as high-tech equipment, will help you keep track of their specific depreciation schedules. Those with shorter life spans will have reduced asset values and thus lower personal property taxes. Computer equipment, for example, can be depreciated at a faster rate than manufacturing equipment or office furniture because it becomes outdated or unuseful so much quicker. Also, equipment subject to unusual wear and tear may also qualify for faster-than-normal depreciation.
The message here, says Huddleston, is clear: Don't just buy a business asset and forget about it. A lot of businesses can drive down their effective tax rates by simply doing a regular review of their fixed assets.
Do As You Like-Kind
In addition to trimming personal property taxes, you may want to review your real estate or other large property holdings and consider what the likely tax consequences will be if you decide to sell the assets. In most cases, if you have a building or piece of land that has substantially appreciated in value, you'll face a huge tax bill when you sell.
One way to defer the taxes you owe is to use like-kind exchange. With this strategy, you exchange your property for some other property you want to acquire without recognizing current income tax. The term "like-kind" refers to the nature and character of the property. It means that undeveloped land can be exchanged for developed property--but you can't defer gains on intangible interests in property, such as partnerships or limited liability companies.
To accomplish an exchange, you'll need an intermediary to carry out the transaction and set up a trust to hold the money from the exchange. The individuals involved in the exchange never actually receive cash.
"With a like-kind exchange, you assign the property to the intermediary, who sells it to a third party. The intermediary will buy the property you want and transfer it to you," explains Maury Golbert, a tax manager and attorney with the New York City accounting firm David Berdon & Co. LLP. In most cases, you can locate an intermediary who will accomplish the exchange for a fee, he says. The fee varies according to the size of the transaction but usually starts at about $1,500.
A like-kind exchange works especially well for entrepreneurs who are looking to expand their operations, says Susan Jacksack, a tax attorney and small business analyst with CCH Inc., a Riverwoods, Illinois, provider of legal, tax and business information. For example, a business owner with a small office building who needs a larger one to accommodate company growth is a good candidate for this type of exchange. "With a like-kind exchange, owners can exchange their property and throw in some cash to receive a piece of property they want," Jacksack explains.
If you add cash to the exchange to obtain a more expensive piece of property or building, that amount is added to the tax basis or cost of the new property. This is especially beneficial from a tax standpoint: By increasing the basis in the new property, the owner ends up with a greater sum to depreciate, Jacksack points out.
If you're on the receiving end of the cash, however, you must recognize taxable income on the money received in the transaction. For example, in an exchange, you get property worth $900,000 and $100,000 in cash for a piece of property valued at $1 million. The tax basis is $100,000. Of the $900,000 gain realized on the sale of the property, you would have to recognize $100,000 as taxable.
There are also a number of technical requirements involved in like-kind exchanges, says Golbert. If you decide to use the like-kind exchange strategy, be sure to work with a tax expert who specializes in that area. For example, the IRS will crack down on efforts to refinance a piece of property before a like-kind exchange takes place. Taxpayers often try to do this so they can take cash out of the property before making the exchange. "The government doesn't approve of that and may assess tax on the money received," Golbert explains.
For the most part, like-kind transactions take some time to accomplish, especially when it comes to finding the property needed for the exchange to take place. Fortunately, the IRS has taken these factors into consideration. Under its regulations, an exchange doesn't have to take place simultaneously; it can be accomplished over a six-month period.
If you're in a position where a like-kind exchange would benefit your tax situation, take the time to consider it. Says Golbert: "This technique not only defers tax, but it can be one of the most economically effective ways to diversify and improve your holdings."
David Berdon & Co. LLP, (212) 832-0400
Grant Thornton LLP, (615) 242-6566, http://www.grantthornton.com