As a business owner, finding strategies to reduce income tax while maximizing profits is crucial for long-term success. Tax professionals each have their own ways of mitigating taxes. That list is long and distinguished, and I am continually learning about them. This blog focuses on an established deduction, but with a twist. This one employs a strategy where the client purchases necessary equipment or vehicles that qualify under bonus depreciation or Section 179. As we all know, it can be used to offset qualified business income. It can also be used to (sometimes fully) offset capital gains. It is easy to see why it could be a potential strategy for some clients. However, several questions will arise. “I’m in a completely unrelated industry. How would I benefit from that?” or “Why would I trade tax liabilities for equipment I don’t need/use?” Here’s another, “Wouldn’t there be tax consequences later when I sell it?” You get the idea.
Fortunately, innovations have been developed and refined to make equipment rental more attractive and viable. Today, you can create an LLC, use leverage to purchase revenue-generating equipment through it and, for a fraction of what you would have paid in tax, create an income stream from a fleet of rental equipment. There is a growing list of professionals and business owners subscribing to this idea. Clients include physicians, CPAs, Wall Street traders and the list continues to grow. Imagine using $100,000 to potentially buy $1 million in equipment (leveraged transaction) that’s already being rented. The revenues are enough to pay all expenses including principal and interest, and still yield a healthy return. Further, there’s an agreed upon buyback of that equipment in year 5 that provides the return of capital plus enough to pay the remaining loan principal. The tax impact means you can potentially create a $1 million deduction against your income by using a fraction of that amount.
By far, this is a preferred way of doing business. If you owned a construction company, and are working on short-term projects, wouldn’t you want the option of renting the necessary equipment instead of having to buy it? This concept is easily understood when you look at companies like Airbnb (which helps people list their real estate for short-term rentals), Turo (a peer-to-peer platform for car owners who want to rent out their vehicles) and COOP (where businesses with idle trucks, vehicles, tractors, trailers and such can rent them out to other companies). Investors are taking fractional shares of ownership in airplanes for the purpose of renting them out. This idea has been around for years, and its appeal is only growing. This equipment rental concept successfully addresses staggering inefficiencies in a multi-billion-dollar industry.
How is this possible?
This idea successfully combines several factors:
- An ongoing inventory of rental equipment that qualifies for bonus depreciation and Section 179. There are several hundred locations nationally where these vehicles and equipment are stored and showcased.
- Leverage that allows investors to pay as little as 10% to 20% of the acquisition cost. This is already arranged for the investors. Financing affords investors the luxury of creating a much higher deduction than they could create with their own capital.
- A nationwide base of construction, industrial and agricultural companies that continually rent equipment. This is projected to exceed $60 billion in 2024.
- Interest income is paid to the investor on a monthly basis. One company has a target net rate of return of 18% on investor capital, paid in monthly increments. While this is not guaranteed, the company who designed this program has never fallen below that target since the program started eight years ago.
- An agreement to market, maintain, insure and, if necessary, repair the equipment. This is all arranged for the investor.
- An agreement to buy the equipment from the investor in future years where:
- The investor receives the original capital
- The investor receives enough to pay off the any remaining principal
- There is a plan to eliminate depreciation recapture in the future
Before moving forward with this concept, make sure you understand what you’re getting into. This concept is most attractive to the highly taxed. There is a minimum amount of equipment purchased. Clients are typically making at least mid-six figures in income. Some are using this as a part of an exit strategy when selling assets.
Bonus depreciation is scheduled to end in December 2026. Currently, you can write off up to 80% in the year the equipment is bought, then use the next five years to use the remainder. If you buy equipment next year, the write-off is lower at 60%; in 2025, it goes down to 40%; then 20% thereafter.
You will be entering the equipment rental industry. To get your deduction, you will need to invest at least 100 hours of work in this business. This includes meetings, research, store visits, among other activities. Such activities should be documented and recorded. It is also advisable to create a separate LLC for this venture.
Remember that this will require debt. That is a risk. The arrangement calls for the investor to receive enough to pay principal and interest every month. The investor also receives enough to pay off the remaining principal during the equipment buy/back. There has not been a time when the companies that offer this program have fallen below target yields. Nevertheless, investors should consider if they have the wherewithal to service the debt if needed.
Typically, equipment is owned for five years, then sold back to the company. At that point, there will be depreciation recapture. Investors typically buy more equipment (using financing) and offset the recapture. While some have issues with this, paying the tax up front (with no planning) is still more expensive.
Also consider your liquidity. This is at least a five-year commitment, so reserve funds for current and future capital needs. You wouldn’t want to sell your rental equipment before the agreed upon buy/back period.
There is risk in any venture and, certainly, there are some to consider here. However, there are many redeeming features as well. Judge Learned Hand once said, “In America, there are two tax systems: one for the informed and one for the uninformed. Both are legal.” Section 179 and bonus depreciation are both well established in the IRC code. There are guidelines in place for this strategy to make sure it complies with tax law. Combined with leverage and the ability to rent the equipment to companies, clients can not only reduce or eliminate their income tax, but they can simultaneously build a fleet of rental equipment. You will likely be seeing more of this activity in years to come. If you would like to know more, contact us. If you would like more information, you can go to www.reignstormgroup.com.