By Stephen Doherty and Jeff Nelson
Dohnerty is Director of National Accounts, Accruit LLC
Nelson is Managing Tax Director, PricewaterhouseCoopers LLP
This Opinion piece appears in the Sept. 5 print edition of Transport Topics. Click here to subscribe today.
America’s trucking industry is facing a daunting array of challenges. Near the top of the list for every CEO and CFO is: “How can I increase my cash flow?”
Many are discovering a source of funds that’s been hiding on their own financial statements — taxes.
Yes, seriously. Through a carefully structured Section 1031 Like Kind Exchange Program, owners of assets used in transportation can benefit from a tax incentive that real-estate investors, primarily, have relied on since 1921.
A Section 1031 LKE program allows trucking companies to avoid current taxable gain when an asset (e.g., tractors and trailers) is sold and a “like-kind” replacement asset is purchased. Consider the following example, which illustrates what happens when 100 trucks purchased new for $100,000 each are then sold for $25,000 apiece:
With only 100 trucks, an LKE program would have provided a million “additional” dollars for the purchase of new tractors.
Cash flow is significantly enhanced by reinvesting a business’ own cash into new tractors and trailers instead of paying it in taxes. In so doing, trucking companies are tapping into an interest-free source of capital to keep their businesses rolling. It is essentially a line of credit that you control — and you decide when to pay it back.
Many potential beneficiaries of a 1031 like-kind exchange program express the age-old adage, “It seems too good to be true.” However, nothing could be further from the truth.
Since 1921, federal tax law (Internal Revenue Code, Section 1031) has permitted a taxpayer to exchange business-use assets for other like-kind business-use assets without current recognition of the gain on sale. Business owners are maximizing cash reserves by minimizing the tax payment in order to reinvest in their businesses. LKE could be characterized accurately as one of our nation’s first and greatest “economic stimulus” programs.
While LKE programs clearly can enhance a company’s cash flow, the importance of “dotting the I’s and crossing the T’s” cannot be overemphasized. Internal Revenue Service tax regulations require that LKE can only be achieved when the “form” of the LKE is accomplished pursuant to very detailed rules of administration. Adherence to these rules and regulations provides a company with a safe harbor that’s acknowledged and honored by the IRS — if the exchange is done properly.
Some trucking companies and dealers occasionally treat trade-ins as LKEs. Such transactions are being scrutinized more closely than ever, and, as a result, more cases of “failure to comply” with proper form for a legitimate LKE are surfacing.
We have consulted with many trucking companies that appeared to be operating outside regulatory guidelines (safe harbor) because of how they were structuring and implementing their exchange programs. Concerns and questions include:
• When do the regulations require a third party — known as a Qualified Intermediary — to hold proceeds and disburse funds?
• Does the IRS really care if an LKE Program does not follow the form of the regulations as long as the trucking company eventually gets like-kind property in return for a trade and the right documents are filed with the trucking company’s taxes?
• Does a “simultaneous” (same day) exchange negate the need for a Qualified Intermediary?
• Do “trade-in” programs qualify for LKE treatment if cash is received from the dealer for trade-ins or the amount is held as a “credit” with the dealership for use in future purchases?
• Can a truck dealer act as a Qualified Intermediary?
• Do “multiple” exchanges require a master exchange agreement?
These are some of the many questions companies should explore with their own tax advisers and/or with a Qualified Intermediary’s LKE program specialists.
At a time when tax authorities are looking under every rock for more revenue, extra care should be taken to be sure exchanges are being done properly. “Business as usual” may not be acceptable for future IRS rulings and audit scrutiny.
The trucking industry’s aggregate fleet age is at a historical high, and the resale value of existing equipment is skyrocketing. With new equipment performance mandates, higher maintenance costs, surging fuel prices, CSA 2010 safety scoring changes and challenges and an exceptionally competitive market for hiring and retaining good drivers — the ability to purchase more new equipment will be a real differentiator in the success of trucking companies.
Cash is king. Carriers with access to greater cash resources will have a distinct competitive advantage in an already hyper-competitive industry. If your company buys — rather than leases — tractors and trailers and sells them at a taxable gain, perhaps deferring those taxes and rolling the full sales proceeds back into replacement equipment through a 1031 Like Kind Exchange Program is a cash-flow convoy worth considering.
PricewaterhouseCoopers LLP, New York, and Accruit LLC, Denver, a personal-property Qualified Intermediary, are in a joint business relationship to provide trucking with integrated Like Kind Exchange Program services.