The Tax Cuts and Jobs Act of 2017 (TCJA) was beneficial to taxpayers in many ways. One would hope so considering the name of the Act. However, there were a few aspects of the TCJA that were unfavorable from the taxpayer's standpoint. Here we will look at just one of those unfavorable provisions in relation to auto dealerships and discuss how to help mitigate the effects.
For most larger businesses, the new tax rules put a limit on the deductibility of business interest expense. Thankfully, the TCJA has an exception for auto dealers, recognizing that floor plan financing is common practice and that the interest on these loans is a substantial expense. This exception for auto dealers didn't come without a price tag.
Let's discuss these exceptions:
- "Business Interest Expense Limitation:" Deductible business interest expense is limited to the sum of the following:
- Business interest income,
- 30% of "adjusted taxable income," and
- Floor plan financing interest (i.e. the interest on loans used to finance motor vehicles held for sale or lease, with the loans secured by those vehicles)
- Floor plan financing interest expense deductions are not subject to the Business Interest Expense Limitation. In other words, floor plan financing interest expense is fully deductible.
- However, there is a catch. In exchange for allowing full deductibility for floor plan interest expense, bonus depreciation (100% additional first-year depreciation) is disallowed on fixed assets purchased in tax years beginning after December 31, 2017.
Important note: The Business interest expense limitation only applies to businesses with average annual gross receipts of more than $25 million for the prior three tax years (calculated in the aggregate for entities in a commonly controlled group). Therefore, auto dealerships below this amount are allowed to take bonus depreciation.
Despite bonus depreciation being disallowed for auto dealers with gross receipts of more than $25 million, there are alternatives to bonus depreciation which allow an immediate deduction for capital expenditures.
- Expense rather than capitalize costs that qualify as repairs or routine maintenance.
- Note: The Tangible Property Repair Regs set forth specific definitions/guidelines for what constitutes a repair or routine maintenance.
- Set a capitalization policy and expense items under a certain dollar threshold. The IRS set $2,500 as the safe harbor limit ($5,000 for companies with a certified audited financial statement).
- Expense up to $1 million of qualifying fixed asset additions using the Section 179 expensing election (increased from $510,000 in 2017). A few things to note:
- Section 179 cannot create or increase a taxable loss (i.e. the entity must have positive taxable income, with certain modifications).
- Passive owners of a passthrough entity cannot take the Sec. 179 deduction.
- Assets qualifying for Section 179 are more limited than those which would qualify for bonus depreciation (e.g. Section 179 cannot be taken on land improvements). Also, buildings do not qualify for Section 179, but some building improvements do.
- If total qualifying asset additions in 2018 exceed $2.5 million, the $1 million expense limit is phased out dollar-for-dollar until completely phased out with total qualifying additions of $3.5 million.
There are other nuances to these rules not covered in detail above, and there are numerous other changes under the new tax laws that could affect your business and personal returns. If you have questions for Delap, please do not hesitate to give us a call at (503) 697-4118 or contact us via email.