Masonry Magazine June 1965 Page. 22
A deduction in the early years of life slightly smaller than the 200% declining balance method is available for the same kinds of property. The chart shown on the preceeding page compares these methods of computing depreciation.
One of the principal considerations in choosing the method of depreciation to be used for tax purposes is the trend of anticipated profits. Timing the depreciation deduction so that the greatest amount of depreciation is taken in the earliest years that profits are expected to put the taxpayer in the highest tax brackets, will result in maximum benefit from the depreciation deduction.
Accelerated depreciation is still valuable even though over-depreciation cannot now be converted to capital gain. Fast depreciation produces a higher depreciation deduction in the early years of asset life, resulting in tax reductions which conserve working capital. The earnings returned by the additional working capital can be substantial.
Closely related to the depreciation deduction is the investment credit. In a sense, the investment credit might be considered a bonus for buying. The investment credit is in effect a cash rebate because it is a direct reduction of the tax due. The credit is not elective, for the Code states it "shall be allowed".
Because the estimated life affects the amount of the investment credit, you should consider extending the life to raise the credit. Let me illustrate: By using a 6 year life instead of 5 year you can increase the credit from 2.23% to 4.67%. Converted to equivalent depreciation the investment credit has these values:
Investment
Useful Life
Credit
8 yrs. or more
7%
6 or more yrs.
4.67%
4 or more yrs.
2.33%
Equivalent Depreciation
48% Bracket 22% Bracket
14.58%
9.73%
4.85%
45.45%
21.23%
10.59%
The increase in the amount of the investment credit will approximately offset the decrease in depreciation resulting from increasing the life. The effect of this is demonstrated in Chart B.
One of the major concerns of a contractor is his working capital position. The amount of working capital influences the amount of work he can bond. The additional working capital resulting from any cash-flow advantage in the early years of an asset's life may be invested in projects which may prove more profitable.
Rental may produce some cash flow advantage because the rental payments are deductible from income as an expense. As expenses increase, income taxes decrease, thus making more cash available.
However, as we have demonstrated, the investment credit with accelerated depreciation can also produce substantial tax savings which tend to equalize the difference so that there is little, if any, tax advantage of rental over ownership.
It should be pointed out that rental merely postpones, it does not save, taxes. Rental preserves (conserves working capital, it does not free it. The contractor should be able to make at least 15% profit on working capital, before taxes, in order to consider it beneficia to rent. This profit would offset the usual additiona costs of rental.
If the return on working capital is low, conserving working capital is costly. With liberalized depreciation policies and with the investment credit, the rental advantages over purchasing have become relatively less important.
Scrap or disposal value should also be considered when weighing rental against ownership. Equipmen with high resale value after normal usage may be ac quired more economically by purchase. In fact, the owner may realize a profit on the disposal of it. Lessor retain title to rental equipment, consequently there i no resulting income to the lessee on the eventual dis position of the equipment.
Ownership also permits one to use equipment as lons as it performs satisfactorily. If equipment will be use a great deal over an extended period of time it wil usually be cheaper and more satisfactory to own it.
In conclusion, there is no magic, clear-cut answe in the question of rental vs. ownership. For tax pur poses, rental vs. ownership is now about a stand-off There seems to be no clear-cut advantage of one ove the other.
So the question of whether to rent or whether to bus will be answered, in the main, by non-tax considerations. When to rent and when to own is an individual matter. It all depends on your particular situation. We have suggested some general points to consider. Only you can supply the answer as it applies to your circum stances.
Perhaps the answer can be found in a statemen made in the February '62 issue of Business Review "Ferret out the real reason for renting. It will soon be come evident whether or not the reason justifies the action".
MASONRY . June, 196.
CHART B
COMPARISON OF ANNUAL DEDUCTION
200%LININGBALANCE YEAR V
YEAR WITH ESTMENT CREDIT
INVESTMENT GREIN BRACKET
INVESTMENT CONTIN BRACKET
LIFE