Since its introduction in 2002 as part of the Job Creation and Worker Assistance Act (JCWAA), bonus depreciation has been part of the economics of purchasing long-lived assets. The common question when a dealership is buying an asset, whether it be equipment, signage, or furniture is “how quickly can I depreciate that?”
Bonus depreciation started as a company is eligible to immediately depreciate 30% of the cost of an eligible newly-manufactured asset, and ultimately became what it is today – the ability to depreciate 100% of the cost of an eligible asset class, whether it be new or previously owned, and expanded into certain leasehold improvements.
This became a depreciation bonanza for dealerships – with refacing projects mandated by the manufacturer and various other “opportunities” to purchase and/or replace equipment, depreciation deductions were all at what I am assuming are all-time highs. Assets were being depreciated all in one year for tax purposes and depending on if you were utilizing bonus depreciation for your dealership’s service loaner fleet, there was a rolling deferral of income due to placing a new fleet in service to absorb gains related to the old fleet coming out of service.
Then the Tax Cut and Jobs Act (TCJA) came into play in 2018. At first, dealerships were going to be subject to a particularly inconvenient code section related to the deductibility of business interest – section 163(j). It was one of the revenue raisers that allowed Congress to use the budget reconciliation process to pass about $1.47 trillion of tax cuts. Section 163(j) was introduced under the guise of forcing American companies to be less reliant on debt to finance growth. The crux of section 163(j), without getting too far into the weeds, is that it requires businesses with average gross receipts of more than $27 million (adjusted annually) to cap their deductible interest expense to the sum of (i) the amount of their business interest income and (ii) 30% of their adjusted taxable income (ATI) (essentially an EBITDA calculation).
Dealerships and their accountants alike were up in arms over this section of the code, especially due to the impacts this would have on floorplan interest, which is generally looked at in the industry as an operating expense like rent or advertising, and not a financing cost. Thanks to lobbying efforts of NADA and various other parties, dealers prevailed and there was a carve-out for floorplan interest. Under this carve-out, dealerships could fully deduct their floorplan interest, without being subject to the limitations under section 163(j) of the code, however, dealerships would lose the ability to utilize bonus depreciation.
The battle for bonus depreciation raged on in the dealership tax world, and, ultimately, it was determined that a dealership would be able to utilize bonus depreciation if it had sufficient business income, and adjusted taxable income to fully deduct all business interest (including floor plan interest) without relying on the floor plan interest exception. The 2018 and 2019 tax years were hit-or-miss for dealerships. More profitable dealerships would be able to take bonus depreciation under the rules, and less profitable dealerships generally would be precluded from taking bonus depreciation. Then 2020 and 2021 happened – dealership profitability soared, interest rates dropped, and inventory levels plummeted. It was a rare exception to find a dealership that couldn’t qualify for bonus depreciation, and the tax deferrals continued.
Here we are in 2022, and profitability remains high, but perhaps not as strong as 2021. There are shadows of a weakening used vehicle market, and with interest rates increasing, there’s some diminished consumer appetite for vehicles. Inventory levels remain low, which has staved off interest rate shock at most dealerships, but there’s expense creep in other areas – salaries, services, etc. There may be another nasty surprise come tax time – the inability for a dealership to take bonus depreciation and those taxes that have been deferred all this time coming due.
In 2022 (as of the writing of this article), the interest limitation formula in 163(j) changes from an EBITDA-based formula to an EBIT-based formula – meaning depreciation and amortization expense are no longer added back to get to an adjusted taxable income amount which is then multiplied by 30% to determine the amount of deductible interest for the dealership. This could mean that a dealership is going to be forced to utilize the floorplan interest exemption (it is not optional), and the ability to take bonus depreciation no longer exists.
For now, inventory levels remain low at most dealerships with most vehicles being delivered to the dealerships from the factory for sold orders. A lot of dealerships are also keeping a high amount of equity in their inventory, which is helping to keep interest expenses low. Something that should be noted is that “floorplan interest expense” is not the amount net of any factory credits, it is the amount of interest paid to your floorplan provider prior to interest credits and any other types of equity offsets.
While this rule change is not limited to dealerships, it affects all businesses that fall subject to section 163(j), which provides little solace. You should discuss asset acquisitions with your advisors to determine how to best structure these purchases to maximize current year depreciation deductions. While these rules could change (stimulus needed due to prolonged economic declines, other unforeseen circumstances, etc.), proper planning and attention to detail are required for your dealership to achieve the best possible outcome.