Cars, trucks, and construction equipment are an essential part of many businesses, especially construction and service companies. Company owners often elect to expense part or all of the initial cost of their vehicles and equipment through Section 179 or bonus depreciation, which provides some advantageous year-of-purchase tax planning opportunities. But what happens when the vehicle or equipment is no longer needed, when it will be traded in or turned over to an owner for personal use?

Selling

When selling a vehicle or equipment, the business will end up with a gain or loss for tax purposes depending on the remaining un-depreciated value as compared to the sale proceeds. Most think when selling an asset, they will recognize a capital gain or loss. However, this is often not the case when selling business property.

In general, the “character” of the gain depends on the amount of depreciation taken on the business asset. Should the calculated gain be less than the overall accumulated depreciation at the time of sale, the gain would be taxed at ordinary income rates, up to the highest prevailing rate in the year of sale—for 2021, 37 percent. If the gain were to exceed the depreciation taken, it is capital and taxed as a short- or long-term capital gain depending on the holding period (more than a year is considered long-term). If a loss occurs, that loss can be recognized as an ordinary business deduction.

Trade-In

Most businesses trade-in a vehicle or piece of equipment in exchange for a newer, better model. Prior to 2017, owners enjoyed the deferral of gain on a trade-in under “like-kind” exchange rules. The owner’s basis in the new vehicle was reduced by the gain on the old vehicle, thus delaying the taxability of that vehicle until it was ultimately sold. But the Tax Cuts and Jobs Act (TCJA) of 2017 removed the like-kind exchange rules for personal property. Businesses now recognize a gain or loss on the old vehicle by comparing the trade-in value afforded by a dealership to the un-depreciated value of that vehicle. Once the gain or loss is determined, the rules for a sale apply to determine its character.

Distribution to Owner

There are tax considerations for an owner taking possession of a company vehicle or piece of equipment or giving it to a family member. The tax treatment of that distribution will first depend on the company’s tax structure; an S or C corporation is treated differently than sole proprietorships and partnerships:

• For corporations, the distribution of the asset results in a deemed sale for fair market value and therefore, possibly, a taxable gain. The fair market value must be calculated in some reasonable manner to help determine any gain or loss. Then the rules of selling the asset come into play with one significant exception: If the deemed sale results in a loss, the loss is disallowed for tax purposes if the recipient owns more than 50 percent of the business, directly or indirectly. While the owner is required to pay tax on any gain, he or she is unable to deduct the loss. If there is a gain on the distribution, then the taxation is the same as a sale, the only difference being the use of estimated fair market value as the sale proceeds.
• For sole proprietorships, the distribution may or may not require recapturing some depreciation when a business-use asset is converted to a personal asset. If recapture is required, the distribution is taxed at the highest prevailing rate in the year of distribution.
• For partnerships, the distribution may require recapturing some depreciation, but there would be additional questions to answer: Was the property contributed? If so, by which partner? How long was the property held by the partnership? Is the distribution to the same partner that contributed the property? Was the asset purchased by the partnership? Is the distribution of the contributed property to another partner? With partnership taxation, unlike corporations, the questions increase in number and the transaction increases in complexity.

Planning

It is always smart to contact your trusted advisor when selling, trading in, or distributing company-owned vehicles or equipment to an owner. Ask what is best for the business, when the transaction should occur, whether a sale or trade-in should even be contemplated, and how the distribution of the asset will affect the owner. If you wait until after the transaction, you may have no options for reducing or deferring taxes.

Contact your HBK Tax Advisor if you would like more information at 772-287-4480.

Just as all jobs are not built the same, construction companies differ in their costs. Contractors need to win jobs to stay busy, but the real trick is making enough profit to cover your costs and have something leftover. Having a customized estimating strategy is crucial and requires a thorough understanding of your business’ unique cost structure.

While your previous year’s numbers might be a good starting point for considering the overhead you need to recover this year, you also need to consider changes you have made that will impact your costs:

• Have you hired office personnel, such as additional estimators, accounting personnel, or secretaries?
• Have you purchased additional trucks for construction supervisors?
• Has there been a significant increase in employee benefits?
• Have you increased your office space by renting an additional facility or adding to your existing office space?
• Do you warranty a portion of your work? Do you have a lag summary to estimate the amount of future claims you might need to cover?

Once you have a budget for your overhead, consider how you will allocate the dollars among your projects. Are all of your projects performed similarly? Are some more labor-intensive while others are more equipment-intensive? An estimating strategy that allocates overhead appropriately will more accurately portray the profit on your jobs and help you submit more competitive bids. No estimating strategy is perfect, nor is it a “one and done” process. You will want to re-evaluate periodically and no less than annually—assuming no major changes in your overhead in the interim.

You can use job estimates for more than winning work. You can compare your estimates during open projects to real-time data to ensure jobs are on track. If something looks awry then investigate. Is something going wrong on the job that’s causing additional work or overruns? Is there a change order or claim that needs to be submitted? Can you make corrections and get the project back on track? Was something missed during the bidding process, and if so, how can you prevent that from happening in the future?

If you find your company consistently losing out in your bidding, consider a bid analysis:

• Are you losing out on one type of job but winning bids in other areas? Is it because your overhead isn’t allocated appropriately? Is your overhead top-heavy and you need to find ways to reduce it?
• Do you have a team of estimators with some hitting bids but others falling short? Do you need to conduct cascade training?
• Are you losing consistently to the same competitors? What are the spread on the bids you lose and they win?
On the other hand, if you are consistently winning bids, build analysis to determine if you are leaving money on the table.

A CPA expert in your industry can help you analyze your business’ unique cost structure to determine where you can afford to make cuts in either your costs or your bids. An industry-savvy CPA can help you find niches in types or sizes of jobs where you can win bids and maximize your profits, and even provide training to your team to get everyone estimating more effectively.

Understanding your cost structure is imperative to helping you attain the profit you require to grow your company and your personal wealth. A CPA focused on the construction industry can be a trusted advisor and provide invaluable support.

As PPP loan forgiveness applications are being prepared by companies across the country, Congress is working on a stimulus package rumored to include provisions that reverse the IRS ruling that expenses paid with forgiven PPP funds will not be eligible for a 2020 tax year deduction. While we’re hopeful that comes to pass, we should be prepared if in fact, these amounts remain non-deductible. To that end, contractors should be aware of accounting issues unique to their industry relating to non-deductible PPP loan forgiveness.

Under IRC Section 460, “small” contractors (under $26 million) have a few options on the accounting method they can use for long-term contracts. One such popular method is the completed contract method, which allows contractors to defer reporting profit—revenue and expenses—until the year in which the job is completed. While this method can produce an attractive income deferral, in 2020 it comes with a caveat. If PPP funded compensation and other expenses remain non-deductible, contractors don’t have to concern themselves with that portion of the costs for jobs completed in 2021 until 2021.

Contractors can also choose to employ the percentage-of-completion accounting method. This method recognizes job profit based on how far a job has progressed at the end of a tax year. All “large” contractors are required to use this method. The percentage of the job costs that have been incurred to date is applied to the total contract price to determine how much revenue must be recognized on that job. However, if these jobs have PPP funded costs that are non-deductible, they should be excluded from the computation, thereby reducing the percentage-of-completion of the job and the amount of revenue to be recognized in the tax year.

Both methods could result in tax deferrals unique to contractors. Understanding how these costs interact with your method of accounting is paramount to ensuring your company is paying the least amount of tax in the event Congress does not overturn the IRS ruling. It will be imperative for contractors not only to document that their PPP expenses were used on allowable costs but also to track them back to the jobs on which they were incurred. HBK Construction Solutions can help you ensure you are documenting and job-costing your costs correctly to be certain you can take advantage of these deferrals and evaluate the various available accounting methods to ensure you maximize the cash retained by your business.