179D and Its Benefits for the Construction Industry

179d

You probably have encountered section 179 and the accelerated depreciation benefits it provides. However, we have found the familiarity with section 179D to be greatly limited. This is discouraging considering the substantial benefits it can provide to those in the construction industry. Let's take a brief look at 179D and highlight its advantages.

What is Section 179D? It is a provision for energy efficient commercial buildings built or upgraded with energy efficient improvements after 12/31/2005. The maximum deduction available is $1.80 per square foot and acts as an accelerated depreciation deduction. The calculation for the deduction (up to the maximum) is based upon the interior lighting, HVAC, building envelope costs and efficiencies. This is certainly a nice benefit for building owners. However, the greatest tax savings are obtained by those in the construction industry, including engineers and architects.

Permanent tax benefit As I eluded to earlier, the 179D deduction is inherently an acceleration of depreciation. Nevertheless, this deduction becomes more than an accelerated deduction for those in the construction industry. Why? The IRS realizes that governmental entities cannot benefit from this deduction due to their tax-exempt status and allows them to allocate (essentially transfer) the deduction to the responsible party for designing the property. This means that this deduction is a permanent benefit (once transferred) that would not otherwise be attainable by the designer. It is a method that reduces the tax burden on each governmental project and increases the after tax earnings for those firms that choose to take advantage of this opportunity.

Please contact your William Vaughan Company representative for further information and for guidance on the facilitation of this deduction.

By: Nate Bernath, CPA

Categories: Construction & Real Estate

Tax Blueprint for the Construction Industry

In an effort to help collect more of the taxes owed to Uncle Sam, the IRS is providing information to educate the construction industry. "Contractors, subcontractors, as well as individual workers need to be aware of everything that counts as income and proper accounting methods so they pay their fair share of taxes," the tax agency stated in a Fact Sheet. "They also need to be aware of all deductible expenses so they don't overpay their taxes."

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The IRS continues to zero in on what it calls the "tax gap" -- the amount between the taxes that are voluntarily paid and the amount the tax agency believes is actually due.

To this end, the IRS has issued a series of documents to provide better understanding of the tax code. One example is specifically directed at the construction industry.

The tax agency emphasizes instances where taxpayers failed to report, or under-reported, income from construction activities. This applies to individual workers as well as contractors and subcontractors. Following are the highlights:

Accounting Methods

Generally, income and expenses are based on either the cash method or the accrual method of accounting. "Either method must clearly reflect a consistent treatment of income and expenses from year to year," the IRS notes.

Many construction businesses use two different tax accounting methods: one for long-term contracts and an overall method for all other items, which is often the accrual method.

1. Accrual accounting: This method requires reporting income in the year earned and expenses in the year incurred. The purpose of an accrual method of accounting is to match income and expenses in the correct year.

Two commonly-used accrual methods are used in the construction industry:

  • Under the "completed contract method," all income and expenses from a contract are reported when the project is completed and accepted by the customer.
  • With the "percentage of completion method," income is reported proportionate to the costs incurred to date as compared to total estimated costs for the contract.
2. Cash accounting: As the name implies, cash receipts are reported as income when received and expenses are reported when paid. For this purpose, "receipt" occurs when a contractor has unrestricted access to income. Contractors who are able to receive money in one year, but chose to defer receipt, must include the cash as income in the earlier year.

Note that a C corporation, or a partnership with a C corporation as a partner with average annual gross receipts exceeding $5 million, may not be allowed to use the cash accounting method.

Deductible Expenses

It is well-established that a construction business can deduct its "ordinary and necessary" business expenses. An "ordinary" expense is one that is common and accepted in the construction business. A "necessary" expense is one that is helpful and appropriate for the construction business. Note: The expense does not have to be indispensable to be considered necessary.

Several common business expenses that may be deducted in the year they are incurred are:

  • Utilities;
  • Car and truck expenses;
  • Advertising;
  • Employee salaries;
  • Trade association dues;
  • Rent expense;
  • Supplies;
  • Continuing education;
  • Small tools expected to last one year or less;
  • Steel toe work boots; and
  • Business licenses.
On the other hand, expenses for business assets that are expected to last more than a year must be capitalized and depreciated over their useful lives. Some examples of these assets include:
  • Cement mixers;
  • Compressors;
  • Ladders;
  • Other heavy machinery; and
  • Buildings and real property.
Be aware that personal expenses such as clothing that can be worn off the job site, fines and penalties, and the non-business use of vehicles or computers, can't be deducted. Other expenses, including certain meal and entertainment expenses, may be deductible in part or only if certain conditions are met.

Reminder: The burden is on you to comply with the prevailing tax laws and regulations. If you have any questions regarding your responsibilities, consult with your tax adviser.

Categories: Construction & Real Estate

Truckers: Highway Use Tax Return Due September 3

The IRS is reminding truckers and other owners of heavy highway vehicles that their next federal highway use tax return, usually due August 31, will instead be due on September 3, 2013. This year's September 3 due date, pushed back three days because the normal August 31 deadline falls on a Saturday, generally applies to IRS Form 2290 and the accompanying tax payment for the tax year that begins on July 1, 2013, and ends on June 30, 2014. Returns must be filed and tax payments made by September 3 for vehicles first used on the road during July. For vehicles first used after July, the deadline is the last day of the month following the month of first use. truckingSome taxpayers have the option of filing Form 2290 on paper. However, the IRS is encouraging taxpayers to file (and pay any tax due) electronically. If you have 25 or more vehicles, you must e-file. In general, the highway use tax applies to trucks, truck tractors and buses with a gross taxable weight of 55,000 pounds or more. Ordinarily, vans, pick-ups and panel trucks are not taxable because they fall below the 55,000-pound threshold. The tax of up to $550 per vehicle is based on weight. Keep in mind that a variety of special rules apply to some vehicles, such as those with minimal road use.

If you have questions about filing this form, or whether you fall under the special rules, contact your tax adviser ASAP.

Categories: Construction & Real Estate

How Business Cycles Affect Construction Firms

shutterstock_800415Small construction companies react differently to economic conditions than their larger counterparts, according to a study by the U.S. Small Business Administration. The study found that smaller construction firms experience a greater negative impact during recessions and a greater positive impact during expansions

The SBA looked at how different firms fared during the ups and downs of the economy in the past 50 years. Here are some of the details of the study, titled Small Business During the Business Cycle:

The entire construction industry grows more than other industries during periods of economic expansion and falls harder when the economy contracts.

However, small firms lose more in a slump, primarily because of their size and stability. Larger companies can usually manage by laying off employees, but small firms may be supplying the larger firms and are less able to downsize. The construction industry is significantly affected by interest rates. Obviously, when the economy is booming, consumers and businesses are more likely to add on, renovate or build new homes and buildings. But interest rates are an important factor. Residential construction boomed in the first few years of the millennium, even though the economy was slow, due largely to low interest rates.

Both large and small construction firms can quickly ramp up when the economy expands, but the smaller ones have an edge.   Bigger companies are easily able to give employees additional hours and higher overtime pay to meet additional business demands. They can also add employees and general contractors. However, smaller firms can expand even more quickly because there are fewer decision makers involved in bidding on and accepting projects. Fewer people and a smaller infrastructure (such as workshops and tools) mean there are less changes necessary to take on new projects. Another reason smaller firms show faster growth is purely mathematical: A $100,000 company that adds $10,000 grows 10 percent. That same total dollar growth for a $1 million company is 1 percent. The ability of small firms to handle the economic cycle can depend on the larger companies. Consumers and businesses control spending more tightly during a slump and resist major expenditures if their own incomes look shaky. As work dries up, the larger construction companies and general contractors don't have jobs to outsource, leaving small companies that depend on subcontracting scrambling to find work. On the other hand, in an upturn, the larger companies can hire smaller companies as subcontractors on some of their lower-margin jobs. Small firms have less pricing flexibility. A large construction firm might be able to survive while losing a handful of accounts and might be able to cut prices to keep others. The small construction business doesn't generally have this luxury. Without as many accounts, any losses are more noticeable, and there isn't a lot of "wiggle room" in pricing.  

Final Word: Wages and benefits rise and fall more rapidly in construction than in other industries as the economy goes up and down. Protect yourself by taking steps during the good times.

Categories: Construction & Real Estate

Increase your cash flow with a cost segregation study!

Most businesses in the current economic climate could use extra cash on hand.  Cost segregation can provide this assistance through immediate tax savings.  If you have purchased, constructed, remodeled, or otherwise acquired real estate (real property) after January 1, 1986, you qualify for this service.   A cost segregation analysis enables the taxpayer to accelerate depreciation on components of the aforementioned real property from 39 or 27.5 years to 5, 7, or 15 years.  This acceleration is what provides the taxpayer with increased depreciation deductions and immediate tax benefits. 

A cost segregation is an engineered study that segregates property (real estate) into appropriate Federal Income Tax Depreciation classifications while maximizing accelerated depreciation benefits offered by the Internal Revenue Service.  The following example is provided to illustrate the benefits that can be derived from cost segregation: 

A newly constructed commercial building (not leasehold property) valued at $1,000,000 would normally be depreciable over 39 years without a cost segregation study.  However, an engineered study would reallocate components of this real property into accelerated lives of 5, 7, or 15 years.  Let’s assume in this example that 10% of the total cost ($1,000,000) was allocated to both 5 and 7 year property, 20% was allocated to 15 year property and the remaining 60% remained allocated to 39 year property.  

Without the cost segregation, total allowable depreciation amounts to approximately $14,000 in year 1 (assuming June placed-in-service date) and $168,000 after 7 years.  In contrast, the reallocation due to cost segregation generates total allowable depreciation of approximately $408,000 in year 1 (including Bonus Depreciation but excluding Section 179 expense) and $501,000 after 7 years.

The increased allowable depreciation produces significant tax savings and an immediate avenue for increased cash flow.  In this example, gross tax savings for year 1 amounts to $408,000 (assuming a fixed 40% tax rate).  Even after 7 years, the gap in allowable deductions remains considerable with $333,000 of increased accumulated depreciation that would have been otherwise deferred to later years.               

Please note that the above example is for illustrative purposes only and does not reflect present value calculations or the results of state, local, and the alternative minimum tax. 

William Vaughan Company offers cost segregation studies based upon guidance provided in the Internal Revenue Code, court cases, and construction cost manuals.  Furthermore, the cost segregation analysis generated by William Vaughan Company’s professional team is tailored to fully comply with the IRS Cost Segregation Audit Techniques Guide.  Please contact your William Vaughan Company representative for further information regarding this opportunity.

By Nathan Bernath, CPA

Categories: Construction & Real Estate