What to do when depreciation runs out.

[ted mcmeekin]

This wash has been great for reducing our personal taxes and providing extra income for our son. I mentioned to our son and he does not want to sell--this wash represents he and wife's identity in this small town. But now we have little depreciation left. I guess we could replace autos or sell out. Mortgage balance is fairly low. Tough decision--or maybe find something else with good write off options. Ideas? Paying taxes is against my religon.

Ted

 

[Whale of a Wash]

We all strive to pay off our business, but as it happens it gets harder to afford our business. I am in the apt business also, and alot of owners do 1031 exchanges to keep up the depreciation, but on another property.
My washes are less than 3 yrs from being paid off and the taxes on the equity i am building every month gets better on equity and worse on taxes every month, so it feels like paying it off is a bad idea, because it
costs so much! My accountant doesn't have any good ideas except to buy more apt properties-- stay deep in debt--Kind of the opposite of what i would like to do--I want to be debt free, but it looks expensive. Anyone
else have any ideas.

 

[Bubbles Galore]

I'm definitely listening because this has been a concern of mine for a long time now...

 

[Earl Weiss]

Color me confused.
Depreciation writeoffs can only be for what you spent (To an extent. You can't depreciate land or goodwill) So, you are only recouping what you spent up front as a tax savings.

Having recouped it all, you now would have to pay tax on the revenue that you could previously apply depreciation to. So, it is not realy a negative situation.

Further, if you sell out right the initial "Profit" over your depreciated basis (recapture) is taxed at ordinary income rates. New rules apply to capital gains over and above those rates. The rules depend on income levels.

If you roll it over with a 1031 exchange, you are rolling over the depreciated basis. To fully escape recapture and capital gain taxes on the transaction your acquired property must be for an amount equal to or greater than the selling price (Not just any profit).
Since you would have to acquire "Like Kind" property, it would be income producing and since it's fully depreciated the income is taxable without available depreciation.
Now, I have had some people choose to roll over into less labor intensive properties. for instance they had a 12 unit apartment building and rolled over into a single ubit commercial space.

 

[Earl Weiss]

My washes are less than 3 yrs from being paid off and the taxes on the equity i am building every month gets better on equity and worse on taxes every month, so it feels like paying it off is a bad idea, because it
costs so much! .

???

Paying taxes on equity building?

As you amortize the loan you have less of an interest expense write off, but you don't pay taxes on building equity.


OK here is what some people do. Re Finance. As long as the revenue stream can service the debt you pocket the refi proceeds and do with it whatever.

DANGER DANGER. If you sell and have to pay tax on the profit you may have little proceeds with wich to pay the taxes. The fact that you re fi'd does not affect profit.
In a sense people who continualy do this never sell. They may roll it over thru an exchange and eventualy have to "Die out of the property" . The heirs now get the "Stepped Up Basis" date of death value so their "Profit" is less. --- So long as tax rues don't change.
One of the catches to eliminating the Estate tax was elimination of the stepped up basis.

 

[ted mcmeekin]

Thanks Earl but now I don't have great solution and my head hurts--kidding.

Ted

 

[2Biz]

Ok...So I'm at total Noob on the subject, so please enlighten me!

When we bought our wash, we took out a business loan @ 7.5% Interest...Yea, the interest is deductable...but the bank gets it all...So a few years after purchase and learning the ropes, we refinanced and used our home as collateral to get a 2.75% rate. It saved us $400.00 a month. That goes in our pockets not the banks, but is taxable...Still we get most of it compared to the original loan...

I've also heard owners on here saying "They Need to spend Money" at the end of the year to avoid paying taxes. I can't for the life of me figure this out, especially if you really don't need anything. So you spend $70 grand or whatever the amount. Which is most of the time depreciated for 7 years...So for ease of calculating, they get a $10,000 deduction for that year saving them roughly $4,000 in tax money. So they spend $70K to keep from owing an additional $4K...

Now, If you had $70k and wanted to pay taxes on it, @ roughly 40% you'd be looking at paying roughly $28k and pocketing $42K...Then you'd be able to spend it on whatever you want.

So I'm having a hard time figuring out what the OP is talking about. His loan is almost paid off and that is a bad thing? At payoff, whatever the payments were just turned into more profit...

 

[pitzerwm]

So far when you buy new equipment etc. using 179 I think, you can write off in that year, was up to $250K, but I think that its less now. Bottom line is that you write if off in the year that you bought it. If you buy more than the max 179 write off, then you depreciate that amount over how ever years the IRS says that you can (more or less the life of the item). For more depreciation you can buy another business/wash and if its a S corp/LLC or sole P then you can take it from all of your income.

Now here is a problem that many forget. Lets say you bought something/business for $500K, you depreciate it over 7 years, and then someone comes along and offers you $750K as that is what things are worth at that time. You now have what is called recapture, in which the IRS requires you to return the deprecation as it appears that it didn't really become worthless.

If you sell this on a contract getting say $200K down, you may find that it all and maybe more needs to go back to the IRS in the year of the sale. Yes, you can do a 1035, (I think it is) exchange and postpone the tax on that sale, but of course you open up new cans of worms. You will pay the taxes eventually, just hope for inflation (another two edged sword) where you pay with cheaper dollars.

Different CPAs have different thoughts as to what is the smart thing to do, but you yourself need to understand the ends and outs of the tax issues, because you are the one that does the paying.

 

[Earl Weiss]

So far when you buy new equipment etc. using 179 I think, you can write off in that year, was up to $250K, but I think that its less now. .................................

Now here is a problem that many forget. Lets say you bought something/business for $500K, you depreciate it over 7 years, and then someone comes along and offers you $750K as that is what things are worth at that time. You now have what is called recapture, in which the IRS requires you to return the deprecation .......................


If you sell this on a contract getting say $200K down, you may find that it all and maybe more needs to go back to the IRS in the year of the sale. ............................................

Last I checked the section 179 Dep was $500K (http://www.fdcpa.com/Tax/0712taxnews-irc-section-179-deductions-schedule.htm) Special rules apply to many things including veicles.

Recapture of Depreciation is taxed at ordinary income rate.

For instalment sales you should only have to pay tax on the pro rated profit portion of the istalment. I don't think the recapture is taxed up front.

 

[washnvac]

Control the revenue.

 

[JMMUSTANG]

Possibly purchasing another wash under the same corp. umbrella and use that depreciation to offset your other wash.

 

[JimmyJaffa]

Sell it to your son, he gets a step up in value, and can take the depreciation on his taxes, he pays you back, and you get to keep more of the money by paying only capital gains rate. It is a little more complicated than this, but close.

 

[robert roman]

Presently, the wash is a known quantity with little outstanding debt to reduce net proceeds in the event a change of ownership. Thus, the principal risk now is business operating risk – will the wash produce sufficient sales.

If the decision is to sell, there may be considerable re-sale market risk because it is a buyer’s market in most areas.

If there is little depreciation tax shield remaining and there has been no retaining of residual value, the equipment would have zero scrap value, affecting market value.

Finding “something else” may provide tax write-offs but it may also present new real estate investment risk and perhaps new property development risk.

If money is borrowed to replace in-bays, depreciation tax shield will be created but debt will also reduce cash flow.

Given the secrets that often surround privately-held companies, my advice would be to hire a financial planner or a CPA with financial planning experience.

 

[Earl Weiss]

Possibly purchasing another wash under the same corp. umbrella and use that depreciation to offset your other wash.

Having different enterprises under one entity presents a liability cross contamination risk. Usualy not a good idea.

 

[Earl Weiss]

Sell it to your son, he gets a step up in value, and can take the depreciation on his taxes, he pays you back, and you get to keep more of the money by paying only capital gains rate. It is a little more complicated than this, but close.

No, this is a zero sum gain proposition because as stated above all depreciation re captured is taxed at ordinary income rates. In addition capital gains rates now vary with income level.

Consult a tax professional before making such a move.

 

[Earl Weiss]

I think the issue here is one of perspective, and a misguided perspective as well.
Simple examples. You buy something for $100,000.00 and you get to write it off over time (For whatever reason it did not qualify for a section 179 expense.) You get the expense until you depreciate it down to -0- recovering the $100K you spent. This expense can be used to offset current income. Once you reach zero you no longer get the depreciation expense, but it's just because you have recovered what you spent.

It's like people saying you should have a mrtgage on your house so you can take an interest expense deduction. But if you have no mortgage the $ you'd pay to the bank stays in your pocket. And you have to pay tax on that.
It's better to keep $ and pay tax on it than pay it to someone else.
(Note; The foregoing ignores the potentila for leveraging debt)_

 

[Indiana Wash]

Control the revenue.

Please elaborate.

 

[Indiana Wash]

Keep it, OP. I mean, it is making money, right? You are not realizing a tax savings any more but you are gaining money.

For example. You make $100,000 per year. You buy a car wash for $1,000,000 with $700,000 of equipment. Lets say the car wash breaks even. You take $100,000 of depreciation a year leaving you with an adjust gross income of $0. (I know it isn't quite that simple but close).

At the end of 7 years, what do you do? You say that the car wash is profitable and not much is owed.

Options:

A. Sell, pay taxes on recaptured depreciation and make $800,000 in one year. If you do this, you will be paying at higher tax rates.
B. Don't sell. You continue to realize a profit. You no longer have additional tax savings but you are still making $100,000 a year and only paying taxes on that. The car wash will be making money when interest is no longer being paid so you will be paying a percentage of your additional income. You just increased your net income.


Also, consult your tax preparer about a stepped up basis upon the death of the owner. That is the only way I know of getting out of recapturing that depreciation. Maybe a section 1031 exchange to an income producing property which you intend to retain until death?

 

[Jim L.]

If you sell a wash you are subject to depreciation recapture. If you sell the stock of the corporation that owns the wash you qualify for capital gains treatment.

This info came from the CPA I use.

 

[Earl Weiss]

If you sell a wash you are subject to depreciation recapture. If you sell the stock of the corporation that owns the wash you qualify for capital gains treatment.

This info came from the CPA I use.

I am thinking this works for a C corp, but not an S corp.

Consult your tax professional.