Should you buy equipment before year end?

Every December, a version of this conversation happens in every contracting business in the country: we had a good year, so should we buy a truck before the end of it to save on taxes?

The dealership will tell you yes. Your brother-in-law will tell you yes. The honest answer starts with a piece of arithmetic that almost nobody says out loud.

A deduction is not a discount

A deduction reduces the income you are taxed on. It does not refund what you spent. Spend a dollar on equipment and you get back some fraction of that dollar in tax you no longer owe — never the whole dollar, and often well under half of it, depending on your rate and situation.

So buying a $70,000 truck to “save on taxes” trades a large amount of real cash for a smaller amount of tax. That is a good trade only if you were going to need the truck anyway. If you were, bringing the purchase forward can be smart. If you were not, you have spent money you did not need to spend in order to avoid a smaller sum.

That is the whole test, and it comes before any tax question:

Would I buy this in March if there were no tax reason to buy it in December?

If the answer is no, stop here.

If the answer is yes, three questions follow

1. Can the cash flow carry it? A December purchase usually means January payments, through the slowest quarter most contractors have. Run it through a cash flow forecast before you sign, not after.

2. What does it cost to own, not just to buy? Financing, insurance, fuel, maintenance, wear parts and the value it loses each year. The purchase price is the smaller half of the decision. See buy, lease or finance, and work out the hourly cost the way an excavation contractor would — because that is what tells you whether the machine can earn its keep.

3. Will it actually be working? A machine bought for tax reasons and parked in the yard for four months is the most expensive thing on the lot.

What your CPA decides, and why you should ask first

How a purchase is treated for tax — expensed immediately, depreciated over years, or some combination — depends on rules that change from year to year and on facts specific to your business: your entity, your income, what else you bought this year, and whether the business is profitable at all.

Two things are worth knowing before the conversation:

• Timing usually turns on more than paying for it. For most equipment, what matters is that the asset is in service and available for use — not merely ordered, paid for, or sitting on a truck somewhere. A machine delivered on January 3 generally belongs to the new year however the invoice is dated.
• A deduction is worth less in a year with little profit. If the business barely broke even, accelerating a large deduction into this year can waste it. Your CPA may well tell you to wait.

Ask them before you buy. The same purchase, made three weeks apart, can land in different years with different treatment, and no amount of bookkeeping afterwards changes which year the equipment went into service.

What the books have to show

Whatever the tax treatment, the bookkeeping is the same and it is where most contractor files go wrong:

• The equipment is an asset, not an expense. A truck coded to “repairs and maintenance” or “equipment expense” misstates the year and leaves your CPA unpicking it.
• The loan is a liability, and each payment splits between principal and interest. A payment recorded entirely as an expense overstates costs and understates what you owe.
• A trade-in is a disposal, not a discount. The old machine leaves the books, and what it was worth against what it was carried at matters.
• Sales tax, delivery, setup and attachments usually form part of what the asset cost rather than separate expenses.
• The fixed asset list is updated — additions, disposals, dates placed in service, serial numbers.

Get that right and the year-end handover is one clean list. Get it wrong and the first thing your CPA does in March is work out what you actually bought. See what your CPA needs at year end.

The better December question

Rather than what can I buy to reduce the tax bill, the question worth asking is what did this year’s numbers tell me to change next year. Equipment is one possible answer. Repricing underperforming work, replacing a machine that is costing more in repairs than payments, or simply holding the cash through a slow quarter are often better ones.

If you do not yet have the numbers to answer that, that is the real year-end problem — and it is fixable before the year closes.

Related

• Questions to ask your CPA before December 31
• Buy, lease or finance? Equipment decisions
• A one-page annual budget you will actually use

General information, not tax advice. How and when a purchase is deductible depends on current rules and on your situation — that decision belongs to your CPA.