Monday, November 19, 2001

Depreciation Bonus Beneficiaries

NEW YORK - The wrangling in Congress has grown intense over the economic stimulus bill, officially entitled the Economic Security and Recovery Act of 2001. The bill, amending certain sections of the tax code, narrowly passed the House of Representatives in late October. It has been under consideration in the Senate since early November.

While some have warned that deadlock between Republicans and Democrats over the bill's scope threatens to derail the legislation, it's a safe bet that neither party wants to be perceived as impeding an economic recovery. Thus, the chances of passage before year-end remain substantial.

Within the proposed law, one measure likely to pass is the "depreciation bonus." Over the next three years, this provision entitles companies purchasing equipment to an accelerated first-year depreciation allowance, equal to 30% of the purchase price of the asset. Andy Laperriere, a Washington-based analyst with brokerage ISI Group, thinks that this provision has a good chance of being included in the final package.

Laperriere and his ISI colleagues provide the following thumbnail example: Suppose a business buys a $1 million piece of equipment, depreciable over years. Under a straight-line depreciation schedule, the business would write off 20% of the equipment's cost, or $200,000, in the first year.

With the new law in place, the business would be able to deduct 44%, or $440,000, in the first year. How? First, the business deducts the bonus, or 30% of the purchase price. In this case, $300,000. Next is a deduction for the amount already allowable as a depreciation from the remaining equipment cost, which in this case is $700.000. A 20% depreciation write-off of $700,000 comes to $140,000.

For companies investing in new assets, the effect of the new provision will be to boost cash flow and provide an up-front break on taxes. "If you do a present value calculation," explains ISI's Laperriere, "it's worth more to deduct now than it is to deduct five years from now."

Houston-based Apache (nyse: APA - news - people ), an independent oil and gas exploration-and-development company, is in a capital-intensive business. In the latest twelve months, depreciation expenses comprised 63% of Apache's cost of goods sold. Given the calls for diminished reliance on foreign oil, drillers like Apache may well see demand for their services rise--along with their need for new equipment.

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