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Equipment Management and Depreciation

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For many contractors, property and equipment is one of the largest account groupings on its balance sheet. For these companies, proper equipment management is a critical success factor and a focal point of driving operations and equipment center revenue. But aside from revenue, there is another income statement item affected by the ownership of property and equipment: depreciation expense. Depreciation is often one of the largest non-cash expenses a contractor recognizes, thus it is important to always consider some key differences between GAAP depreciation and tax depreciation.

A majority of property and equipment items for contractors will have GAAP useful lives between three and seven years. There are multiple GAAP depreciation methods a company can use to calculate depreciation. The most common method is straight-line, where depreciation is recognized evenly over the useful life of the asset. This method is calculated easily and allows for a consistent expense over the life of the asset. Another popular depreciation method is units of production, where depreciation is recognized based on equipment usage. This enables a company to more accurately match depreciation expense with the revenue earned from the use of the respective asset. Although uncommon, a company can also apply double-declining depreciation where the company recognizes more depreciation in the early years of an asset’s life. When commonly used depreciation methods are applied, book depreciation is relatively stable and consistent over the life of the asset, especially compared to potential tax depreciation allowances.

Equipment depreciation under IRS code rules differ from GAAP depreciation rules as they permit more initial depreciation to be recognized. One method for accelerating tax depreciation is with the Section 179 deduction. With this, a company can expense up to $510,000 of qualifying equipment purchases made during the year, with a dollar-for-dollar phase out beginning at $2,030,000 of additions. This is a terrific way for a business to lower its taxable income, especially for contractors who consistently purchase equipment each year. There is also bonus depreciation available for qualifying equipment purchases. With bonus depreciation, a company can expense an additional 50% of new equipment purchases after using the Section 179 deduction. For example, if a company purchases $710,000 of equipment in 2017, it can expense $510,000 with the Section 179 deduction and $100,000 of the remaining $200,000 of purchases with bonus depreciation. The company would then depreciate the remaining $100,000 over the useful life of the asset (generally five years for tax purposes). These deductions greatly reduce the amount a company pays during the year for taxes, providing for a significant deferral of taxes.

Overall, it is important to recognize the difference between GAAP depreciation and tax depreciation. It can be advantageous to use tax deductions related to equipment to reduce taxable income and recognize significant cash savings. If applied correctly, a company can develop a new appreciation for depreciation.