For retailers looking to finance c-store upgrades, offsetting the cost of new fixtures, equipment or a remodeled store can be done more easily because of revised rules allowing for bigger and faster write-offs.
By Mark Battersby, Contributing Editor
Last December’s Tax Cuts and Jobs Act (TCJA) not only slashed tax rates, it allowed many within the convenience store industry to expense and immediately write-off the cost of much-needed business upgrades.
Unfortunately, the new law keeps the general 39-year recovery period for so-called nonresidential real property such as a store building. While the favorable treatment for improvements made to leased, retail and restaurant property was eliminated by the TCJA, the means for writing off the cost of new fixtures, equipment or a remodeled store can be done more easily because of revised rules allowing for bigger and faster write-offs.
WRITE IT OFF
For all property acquired by the convenience store business and placed in service after Sept. 27, 2017, the TCJA allows a full 100% deduction for the cost of eligible new and used property unless the convenience store operation chooses not to claim the depreciation write-off for any class of property.
The new law eliminates the requirement that the original use of the qualified property begin with the convenience store business, so long as it had not previously used the acquired property. What’s more, if the property was not acquired from a related person or business it can qualify for the 100% deduction.
Section 179 is an incentive designed by lawmakers to encourage businesses to buy equipment and invest in their operations. In essence, Section 179 allows a convenience store business to deduct the full purchase price of equipment and/or software purchased during the tax year. Thus, if equipment or other property is purchased as part of an upgrade, the full cost is deductible as an immediate expense.
Under our tax rules and the new law, a convenience store business can choose to treat the cost of Section 179 property as an expense and deduct it in the year the property is placed in service. The new law increased the maximum amount that can be deducted from $500,000 to $1 million and the phase-out threshold from $2 million to $2.5 million.
The TCJA also expanded the definition of Section 179 property to include improvements made to a building’s interior. Of course, the expenditure doesn’t qualify if due to:
• the enlargement of the building,
• any elevator or escalator, or
• the internal structural framework of the building.
The most important difference between the Section 179 first-year expensing allowance and bonus depreciation has long been that both new and used equipment qualified for the Section 179 deduction. Today, however, bonus depreciation includes used equipment.
The Section 179 deduction is usually taken first, followed by the Bonus depreciation. Generally, Bonus depreciation is useful to very large businesses spending more than the Section 179 spending cap (currently $2.5 million) on new capital equipment. Of course, businesses with a net loss can still deduct the cost of new equipment and carry the loss forward.
Whether the recent trend of mergers and acquisitions (M&A) is attributable to last December’s Tax Cuts and Jobs Act (TCJA), the cash it freed up or the new lower corporate tax rate, M&As are on the upswing—with a great deal of the action involving smaller deals.
The use of warranty and indemnity insurance to remove all or a great deal of the risk in M&A deals is yet another factor in that reported upsurge.
Acquiring another business is one way of upgrading the convenience store operation. An acquisition refers to the purchase of one entity by another. An acquisition can also involve acquiring only the assets of another business.
In a purchase of assets, one business acquires only the assets of another business. Asset purchases are common during bankruptcy proceedings, where other businesses bid for various assets of the bankrupt business, which is liquidated after the final transfer of assets to the acquiring business.
PAYING FOR IT
Adequate funding is necessary to finance c-store upgrade since there is little doubt that upgrades are expensive. Fortunately, paying with cash is an obvious alternative. After all, cash transactions are instant and relatively mess-free. Unfortunately, smaller convenience store businesses without large cash reserves must usually seek alternative financing options in order to fund many transactions.
Another option, the U.S. Small Business Administration (SBA) doesn’t do much lending. Rather, the bulk of its financing comes in the form of “guarantees.” The SBA guarantees the repayment of loans made by a bank or other financial institution, thereby lowering or reducing the institution’s risk and, in most cases, the amount of interest a borrower is charged.
The SBA’s primary and most flexible 7(a) Loan Program is the most popular loan program, providing up to $5 million for refinancing, working capital or to buy a business. Even larger transactions are possible with so-called “mezzanine” financing or when real estate is included.
The SBA’s CDC/504 Loan Program provides long-term, fixed-rate financing to acquire fixed assets (such as real estate and equipment) for expansion or modernization. It’s ideal for small convenience stores requiring “brick and mortar” financing.
Rather than through banks or other commercial lenders, 504 loans are delivered via Certified Development Companies (CDCs), which are private, non-profit entities set up to contribute to the economic development of their communities.
The SBA also has a unique program to provide small (up to $30,000), short-term “microloans” for working capital or the purchase of inventory, supplies, furniture, fixtures, machinery and/or equipment. Ideal for those needing small-scale financing and technical assistance, the SBA microloan is delivered through specially designated intermediary lenders (non-profit organizations with experience in lending and technical assistance).
The TCJA’s new tax rates and the promise of a smaller tax bill, is likely fueling the upgrading plans of many within the convenience store industry. Other provisions of the TCJA, such as the full-expensing of asset costs, may cause many to weigh their effects on any transaction.
Obviously, these challenges are not insurmountable and acquisitions continue to emerge with and without tax breaks, alternative financing and risk insurance.
As for those other upgrade strategies, expensing or immediately writing-off their cost is not always the best option. Expensing drops the book value or basis of the newly acquired asset to zero. That means, if the asset is sold, any amount up to the purchase price will be ordinary, fully-taxable income.
Spreading the cost of improvements and upgrades through depreciation deductions will help offset or reduce taxable income down the road when the upgraded or improved convenience store business may be more profitable and have higher tax bills. Another time that immediate expensing may not be the most economic route is when the asset might be sold in the near future and/or the asset is one that holds its value.
The changes in the cost recovery rules are already having a significant impact on whether newly acquired equipment or business property should be depreciated or expensed and whether to choose bonus depreciation or choose not to claim bonus depreciation.
Because the new rules interact with other provisions of the law, every convenience store executive, owner or operator planning to upgrade or improve their operations should seek professional advice and assistance before attempting to maximize—or postpone—upgrade write-offs.