Good morning, everybody. We'd like to thank you for coming and attending the Taxes and Your Rental Business webinar this morning. Before we get started, I would like to let you know that there is a dialog box where you can ask questions and that the copy of today's webinar will also be made available to participants at the conclusion of the webinar and will be available from the AED on an ongoing basis. So for today's presentation, we are going to be having Dave Fowler, who is a tax partner with PWC, Patrick Mahoney, who is a tax partner with PWC, and Steven Doherty, myself, who is the Director of National Accounts at AccruIt. And we're also going to have Craig Schultz participating. He may be offering input and moderating some of the audience questions. So moving forward, I wanted to give you some background. We're going to be delivering this PWC and AccruIt together. We've been delivering an integrated tax and QI LKE solution to the marketplace for going on seven years now, which provides both tax and QI. We've both been members of the AED for over 15 years. We are currently the preferred provider of like-kind exchange services for all AED members. And just a quick blurb on our LKE work. PWC's LKE technology currently manages over 35 million assets each month. Our QI services manages over 30,000 financial transactions each month. And we have a 15-year investment in technology staff and tools. And this is some of the things we're going to be covering today, is the growing rental fleets and some of the issues surrounding that for you guys, depreciation and gains, where like-kind exchange fits into this equation, dual-use property, some of the new leasing standards, and then certainly we're going to have some time for some Q&A. And so for the next section, I would like to introduce you all to David Fowler, who's a tax partner with PWC and head of their national 1031 LKE practice. Dave? Dave, you might be on mute. We're not hearing any. Okay. Sorry about that. Good prompt. Thanks, Steve. This is Dave Fowler. As Steve mentioned, I am a tax partner with PWC. I've been working with equipment dealers now for the better part of 20 years or so. To add to Steve's opening comments, I would just indicate that if the audience wants to ask any questions today, I think there's a dialogue box on your screen. You could post your questions there, and we should be able to answer those questions as we move along. To kick things off today, I think we'd just like to start off talking a little bit about the growth in the rental fleets and why we here at PWC and our crew at AED thought this was an important topic to cover on the webinar today. Craig, if you could go to slide seven. There were some interesting statistics here with respect to the growth in rental fleets that was published by the Monitor. It's a leasing publication. The article was drafted or authored by the folks at Wells Fargo, their equipment finance group. But in that article, they've just noted the size of the amount of the increase in the rental fleets and the rental business, the equipment rental business. It's quite astonishing. Over the last five years or so, they noted that rental fleets, as measured by original costs, had increased by about 55%. In the last year, this report was published in late 2015. So for June of 2014 to 15, there had been about a 13% increase for the large rental houses and for the equipment dealers, their rental fleets had increased by about 18%. So some significant growth there. The other thing that I thought was sort of noteworthy in this article is the increase in rental rates over the last four or five years. For what it's worth, the article did note and the participants on the call today might realize this, that there was some softening in those rates in the last year or so. But on average, there's been a nice trend in an increase in rental rates and hopefully the overall profitability of that business. Back on slide six, we just wanted to note and probably reiterating some of the things that the industry participants are already aware of, but a lot of this growth has been organic in terms of growing the equipment rental fleets for the dealers, but really is being driven by changes in market conditions and the demand to your customers. The contractors today are oftentimes less willing to commit to buying equipment because of the uncertainty in business projects, uncertainty in governmental funding, if you think about the highway funding bill, the specialization of equipment, increasing cost. All those sort of market conditions are driving the end users toward more renting and less ownership. Those market conditions have been, I think, influenced as well by maybe still some continued weak financial conditions for the end users. So maybe they're not able to get the financing to buy the equipment. In some cases, bond companies for the contractors and others are trying to encourage the contractors to improve their balance sheet. Oil and gas here, this might be a bit of a drag on the rental industry, but that volatility within that marketplace also seems to be driving people toward more rental and less ownership. Lastly, as you all know, the manufacturers, the OEMs, have also introduced a number of different programs to help with the funding, the financing, and the holding of rental equipment. I think we put that in context with the historical activity of dealers. These trends have probably been ongoing for the better part of 15 or 20 years now. But historically, before the activity started trending more toward rental, dealers were involved primarily in selling the equipment for the OEMs that they represented. There was obviously part sales and servicing that went along with that. But with the growth of the rental fleets, the influence of the rental operations on the overall tax position of the dealers has increased. As we're going to discuss today, those tax benefits can actually help enhance cash flow and in some cases might even help to finance the rental fleet itself and some of the cost that goes along with that. Because from talking to our clients, I think many have experienced some challenges in terms of financing that rental fleet and the changes that have occurred on the dealer's overall balance sheet with respect to having to carry those assets on the balance sheet. If we get into the meat of the discussion today, on slide nine, we have depicted here just a very simple income statement, a calculation of taxable income for rental fleets to kick off this discussion. Through the life cycle of the ownership of rental equipment, there's the purchase, there's the ongoing rental of the equipment, and then there's the ultimate disposition. Over on the right-hand side, again, we've provided kind of a simple income statement. That activity is going to generate rental income. There's operating expenses associated with it. We'll talk more on the depreciation expense and there could be an interest cost to carry the equipment. You'll note in these numbers, and they are fairly reflective, the kind of size what we have here, this is really just kind of an example of what some numbers might look like for four pieces of equipment. The idea of a dealer kind of buying a piece of equipment every year, holding it two years, and then selling it within that third tax year. This is sort of that small size kind of rental fleet. You could scale this for your actual operations. What's important to note here with bonus depreciation, we'll talk about that a little bit more, is that the rental activity through the rental period of the equipment typically throws off a fairly large tax loss. That loss can be used to shelter the other activity of the dealership and thereby increase the cash flow. At the time the equipment is sold, there's depreciation recapture. We'll go into that calculation a little bit more. There could be a significant tax burden, but there are also some planning opportunities there. Today we're going to focus around the calculation of depreciation, the gain, some opportunities to defer that, and then some other IRS considerations with respect to those items. If we get into the maker's depreciation, I think it's probably worthwhile noting here that for a lot of non-tax people, maybe even your sales folks, your business folks, and perhaps the owners or the principals of the dealership here, oftentimes when you talk about having gains on the sale of equipment or accelerated depreciation, that's a little bit of a foreign concept for them because they're thinking about how the assets might be depreciated for financial statement purposes or for your books in terms of a book-carrying value. There you're trying to depreciate the asset in a way that it reflects a decline in market value. But under the tax rules, you're allowed to make accelerated depreciation. In the first year, there's a 20 percent depreciation calculation, 32 percent in the second year, and 19.2 percent in the third year. If we think about a two-year holding period for a moment, assets will generally be carried or held over three tax years. Something you might buy sometime in 2014, let's say. If it's held for 15, it would be disposed of in 2016. In the year of disposition, there's a half-year convention. Instead of being entitled to the 19.2 percent, the taxpayer would be entitled to half of that amount or the 9.6 percent. If we carry that on into what's that look like for a single piece of – well, let me backtrack here a little bit. The other thing that's worth noting here, those rates that were on the previous slide, they're the normal makers of percentages. As many of you probably know, the U.S. tax law has provided for bonus depreciation for a number of years now. Bonus depreciation was first enacted after 9-11, back in 2001. It was first enacted at 30 percent. It was increased to 50 percent in 2003 and 2004. It actually expired, if you remember that, in the period from 2005 to 2007. Then when there was the economic downturn and the recession, bonus depreciation was reinstated at 50 percent in 2008. It was actually increased to 100 percent in the 2011 tax year. There's a little piece of 2010 where there was 100 percent bonus depreciation. Then from that time forward, as you all might recognize, we kind of went through the series of bonus expiring and then sort of retroactively being reinstated at a 50 percent rate. At the end of last year, so late in 2015, you might recall bonus had expired once again in 2015 with the beginning of the new calendar year, but with the tax bill that we got or the tax act that we got late last year, bonus was reinstated, reenacted, and it is now being phased out over the next four or five years, being reduced to 40 percent in 2018 and 30 percent in 2019, and then it sunsets or ends at the end of 2019. So, you know, while dealers can depreciate, you know, up to 50 percent plus the regular maker's amounts in 2016 and 2017, that bonus depreciation amount will start to decline in 2018 and is gone after 2019. So to get into an actual calculation here, a single asset calculation, we've just got a simple example where there's a front end loader being acquired for $200,000. Again, we've kind of stuck with this two-year hold period, and then in the third year, the third tax year, this piece of equipment in our example here will be sold for $170,000. So if we look at the calculations over that three-year period, the taxpayer, the dealer in this particular case, can deduct, receive a $100,000 tax deduction in year one for the bonus depreciation, and then there's a 20 percent deduction on the remaining amount, the remaining $100,000. So there's an additional deduction of $20,000 year one. Then the taxpayer's entitled to a $120,000 depreciation deduction. That sort of drives this tax loss that we were talking about in the earlier slide, and that tax benefit can be used to shelter other income, finance or pay for this particular equipment or be used for other purposes within the business. In year two, 2015, in our example here, the dealer's entitled to a $32,000 deduction, the 32 percent statutory rate times the 100 percent amount that's left after the bonus. Year three, we're down to 19.2 percent rate by statute. We have the half-a-year convention. There's $9,600 of depreciation, and then year three is the year in which the equipment's disposed of. So we've also shown here the calculation of the tax gain. After the depreciation was taken in 14, 15, and 16, for tax purposes, this piece of equipment only has a remaining basis of 38.4. It's being sold in our example for 170, so there's a tax gain of $3,000. We have $131,000 on which tax has to be paid. So there's a significant recapture of the depreciation and a tax burden that is due in 2016, and to a great extent, kind of reverses those tax benefits that were received in the earlier two years. So I think at this point, I'd like to turn things over to Pat, and he's going to talk a little bit about Lycon Exchange for equipment dealers and how that can be used to avoid the tax gain on the disposition of the equipment. Pat? Great. Thanks, Dave. This is Pat Mahoney. I'm a tax partner at PwC. As Dave said, I'm going to talk a little bit about Lycon Exchange. So as we just discussed, accelerated tax depreciation, receiving bonus, creates a great incentive, a great tax incentive to stimulate investment in business properties. However, that accelerated depreciation and bonus incentive also inadvertently creates almost a tax disincentive to selling the business property at the end of its life. That disincentive is that tax on gain upon disposition. The tax code has provided a remedy for that conflict that allows the taxpayer to take accelerated depreciation and bonus depreciation related to the investment in business property, while also deferring the recognition of tax gain when you later sell those properties. That tax remedy is known as Lycon Exchange. We'll spend the next few minutes talking through the LKE, as we call it, remedy. So as you look at slide 15, that is the code section reference. So section 1031 of the Internal Revenue Code provides us this Lycon Exchange treatment and essentially states that, no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of Lycon, which is to be held either for productive use in trade or business or for investment. So essentially what Congress has done here is allowed us to realize gain on sale but not have to recognize that gain for tax purposes. Essentially recognizing that that would create what we discussed earlier, a conflict between the incentive to invest in new properties and that disincentive to sell. A couple key points here is property of Lycon, when we think about a construction equipment, we think generally, and Steve's going to talk about this a little more in a few minutes, but we think generally all construction equipment would be of Lycon. So a backhoe loader would be of Lycon to a dozer. A backhoe loader wouldn't be of Lycon to a car, but for our purposes, your rental portfolio is made up primarily of assets that would be of Lycon. If we move on to slide 16, we're going to go through a very similar scenario, the exact same scenario that Dave just went through as he talked about tax depreciation, but now we're going to layer in Lycon Exchange. So same facts, original purchase price $200,000, accumulated depreciation $161,600, potential sales price of $170,000, potential gain on sale $131,600, and the tax liability associated with that gain of $52,640. We'll walk through this in greater detail, how we're able to actually defer that tax gain, or that tax liability through a Lycon Exchange. So if we move on to slide 17, we've got that same presentation. You'll notice that columns 2014 and 15 are identical to what Dave had just walked through. 2016, no LKE, so that's without Lycon Exchange, also identical to what Dave had just walked through. But the new column we have here is 2016 with LKE. So essentially what is happening is we're still getting our tax depreciation on the half year for that asset. And then when we sell the asset, we are able to defer that gain. So the impact on tax liability is the $9,600 decrease to taxable income, and then our tax liability is the 40% of that. So we get a tax benefit of $3,840 associated with that depreciation. And the difference between the $3,840 of tax liability relief and the $4,880 of tax liability in the no Lycon Exchange example is essentially the benefit generated by Lycon Exchange. That's our net tax cash savings associated with doing this Lycon Exchange strategy. So that's a pretty good benefit, especially if you think about it on a one-off transaction. If we move on to the next slide, we're going to see kind of the requirements and what we need to do to accomplish that. So before I talk through these seven steps, I'd like to just kind of lay out the slide a little bit and talk about the different boxes. Obviously at the very top we've got the taxpayer. So in our discussion, that's really our concerned party. And for you all on the phone, that would be yourselves as the dealer. Next we have the buyer in the bottom right-hand corner. So that would be any third party that's going to purchase your off-rent assets, whether that be directly from you or through consignment or through an auction house. In the bottom right-hand corner we have the seller. So that would be your OE who's going to sell you new construction equipment for your rental portfolio. And then in the middle we've got this lender who may or may not be involved. Essentially could be lending you money to make these purchases and you may need to also pay down debt on a periodic basis. Finally we've got the qualified intermediary right there in the middle of our diagram. And the qualified intermediary is going to facilitate the exchange transaction. For most of you, all of those parties I went through would be very familiar with the exception of the qualified intermediary. That's really the new party in this arrangement. And as I said, the QI, as we call them, they create the exchange. So said differently, if we took the QI out of the picture, you would essentially have your normal sale and purchase process exactly as you have it today. The introduction of the QI changes the nature of the transaction from a normal sale and purchase to an exchange, which is what we're obviously trying to create so that we can have a like-kind exchange and like-kind exchange non-recognition treatment. I think it's important to just pause here for a moment and just remind everyone on the phone that this LKE structure is exactly how Congress and the IRS envision this deferral taking place. What we've diagrammed here is exactly what's defined in the code. It's essentially Congress's intent to allow taxpayers to defer recognition on taxable gains as long as they're reinvesting those proceeds in continuing business. So this is the methodology provided to us and prescribed by Congress. So with that in mind, I'm just going to walk through these seven steps. The first step we have, number one, is the assignment of rights in the sales contracts. So essentially as a taxpayer, you have to assign to the qualified intermediary your rights in those sales contracts. You may do that through a contractual arrangement. We oftentimes call that the Master Exchange Agreement or MEA. Next, you would do a direct transfer of your relinquished property to the buyer. That would be really no different than what you do today. You would interact with the buyer or you would interact with the auction house. The qualified intermediary is not reaching out to the buyer. You're doing all that on your own. Maybe the only differences would be what happens with the funds that the buyer is going to send to you and that you also have to include notification to the buyer that a like-kind exchange is taking place. We'll talk about that a little bit more in a minute. The buyer would then remit those sales proceeds to the qualified intermediary. Now we've got we've got a box four here and I'll just say quickly that there are two sort of separate alternatives for cash management. The traditional alternative would allow those funds to accumulate at the qualified intermediary and be held until such time as you're ready to purchase replacement property. So the funds would go into that QI box. They would stay there until you're ready to purchase replacement property at which point the QI would send those funds to the seller or the OE. An alternative is and if all the facts align would be that to the extent the assets are held subject to liability, the qualified intermediary can immediately pay down the debt associated with those assets. And then when you need to make new purchases, you would just borrow against that line of credit and pay the seller at that point. So the traditional method would be the buyer remits to the qualified intermediary. The intermediary holds the funds until we're ready to make our purchase and then disperses at that time. The second approach which is equally as valid would be to have the qualified intermediary immediately pay down the debt. So the benefit of that is obviously that we don't have cash sitting at the qualified intermediary as we wait to make our purchase. So once we remit those funds for the replacement assets, the assets are then directly transferred again to the taxpayer. So once again, the intermediary doesn't have to take hold of those assets. Again, they only have the rights in the purchase contract. So those assets go directly back to the taxpayer. Okay. So as we move on from slide 18, you know, we talked about the structure a little bit and how we changed that. Through that structure, we're able to change that transaction from a sale and purchase to an exchange. But I also kind of refer to the ability to do these exchanges on a non-simultaneous basis or on a deferred exchange basis. And this slide diagrams the timeline associated with a non-simultaneous exchange. So, you know, a simultaneous exchange, a good example of that would be, you know, I've got a construction equipment that I have out to rent. And instead of selling it through a third party or selling it through auction, I go back to the OE and I do a trade-in. I give them the off-rent asset and maybe some dollars and I acquire a new asset. That would be a simultaneous exchange. But that's what not the normal course of business. The normal course of business is that we're acting or interacting with several parties. And in those cases, we have the opportunity to use a deferred exchange. So when we think about the timeline for a LICON exchange, unlike a normal asset life cycle or really most timelines, the timeline for LKE exchange really starts at the end. It starts with the sale of our asset. So in our example, the sale date is day zero. And that transaction kicks off the exchange period. From a tax requirement perspective, there are several steps that we need to complete prior to that sale date. Namely, we have to assign our rights in the sale of that asset to the QI. As I said earlier, we would do that through some legal contract between the taxpayer and the QI. And normally, we would call that the master exchange agreement. We also have to notify the buyer of that assignment. The notification, generally, how that would occur would be through a new term in the purchase order or through a separate notification letter. There's no requirement that the buyer acknowledges that notification. They just have to receive that notification. On the sale date, then, we have 45 days to identify our replacement property. The replacement property is the property we're going to purchase to replace the relinquished or sold property and complete our exchange. We can identify the asset in one of two ways. We can either purchase the replacement property and match it to the sold property within 45 days. So you know, day zero, we sell the asset. Fifteen days later, we buy our replacement. We've essentially identified. Or we can provide written notice to the QI of properties that we intend to purchase in the future and extend that exchange period beyond 45 days to the lesser of 180 days or the filed return. So 180 days gives us quite a long landing strip to purchase our replacement property, close to six months in most cases, to really purchase that replacement property and complete our exchange. The only thing left to do at that point is to file your return and finalize all your matching, do your gain-loss calculation, tax depreciation, and then finalize your return. It should be noted that during this exchange, while this exchange window is open, the funds do, the sales proceeds do need to remain with the QI. Those funds should only be disbursed from the QI account to purchase replacement property. And to the extent the exchange period expires without the purchase of replacement properties, at that point, those funds could then be remitted back to the taxpayer. With that, I'm going to let Steve talk a little bit about single LKEs and what those might look like. Thank you, Patrick, very much. I wanted just to remind you, based on what Pat said, that it's the introduction of a qualified intermediary into your sales process that allows you to convert that sale into a like-kind exchange, which enables you to defer those taxes, which averages, depending on where you are in the country, about 40%, which is a pretty good chunk of change when you're talking about a guy selling and losing that versus keeping it to buy new equipment. I'd like to talk with you a little bit about single exchanges. Fifteen years ago, Accruit developed a web portal to simplify the single exchange process down to about 10 or 15 minutes. All of the following LKE requirements that you see there on your slide, assigning the rights through an executed exchange agreement, providing notification of assignments of rights to parties involved in the transaction, proper identification protocols, and avoiding constructive or actual receipt. We've developed this process for AED members. It's the same process that every single Ritchie Brothers customer gets access to when they do a single exchange. That whole process takes about 10 or 15 minutes, very much simplified. What is like-kind property? As Patrick was mentioning, it's different in different industries. Airplane for airplane, truck for truck, things like that. The nice thing about your industry is that it's probably the most liberal in terms of identifying what constitutes like kind. Construction equipment, for construction equipment, the IRS views as a very broad expanse with regards to selling A and perhaps replacing it with C, D, or E in terms of different kinds of construction materials. Like class refers to tangible, depreciable personal property that also falls within general asset class or any ICS codes. The one reminder I'd like to have to remind you of is that your customers also very much would like to be made aware of this. Your customers coming in with a sale or a consignment or something who are unaware that like kind exchange treatment can be extended onto their transaction immediately become the recipients of a potential 40% back in their pocket to use in your store. So again, it's just not unique just to the dealers and whatnot. This is something that very much can be communicated to your customers to enhance the sales process in terms of injecting that much more money into your customers' pockets. So with that said, beyond simple exchanges, sometimes the volume of your equipment selling and buying necessitates a more robust solution. In this case, as many of you in the AED already know, you may want to consider a 1031 like kind exchange program, which is a repetitive basis that has some unique characteristics over and above a single. And for a discussion on this, I'm going to turn you back over to Pat Mahoney, PWC tax partner, who will speak to this category of LKE. Great. Thanks, Steve. When we think about the single arrangement, single LKE arrangement is really most relevant, as Steve said, for kind of our one-off, infrequent, large transactions. A common example might be the sale of real property or a high dollar personal property items that are, again, transacted on an infrequent basis like aircraft or construction equipment for a dealer that are only selling a few off-run assets each year. In those instances, this one-off solution is very beneficial. However, for larger dealers that are completing multiple transactions a month, there is another LKE structure that allows you to meet the tax requirements with minimal incremental business or legal processes on a transactional basis, but you still satisfy those requirements. Essentially, what you would do is you go through a process and you go through procedures to kind of map out your existing business processes one time, and you overlay the tax requirements to allow you to meet those tax requirements every single time without really having to think about it. A simple example would be that master exchange agreement where, with a one-off transaction, you are going to specifically assign your rights in certain assets that you are about to sell and, similarly, to certain assets that you plan to purchase. For a program, for a repetitive LKE program, the MEA would be written a little differently so that you would assign your rights in all future sales and purchase contracts to the qualified intermediary. Similarly, we talk about notification language. We need to notify the buyer and seller. So in a one-off transaction or a single transaction, you would make sure that you get that language into your documents. You might include a letter that specifically provides that notification. In a repetitive program, you would look for a methodology to automate that process. So you might put that language into every PO that is intended to purchase rental equipment or every sales invoice that is the sale of rental equipment. So through that process, you are able to automate these LKE requirements. The final one would be the cash structure. So we would want to make sure that we have a process to automate how we are able to remit cash through the qualified intermediary and make payments. Those are all things that can be built into your processes so that on a transaction-by-transaction basis, you don't have to think about like-kind exchange. You are just satisfying the requirements every time. That is what we would call a repetitive like-kind exchange program. There is very specific guidance on that type of program that is under Revenue Procedure 2003-39, and we will talk about that a little bit more. But first, what we would like to do is just kind of go through another example and talk about the benefits of a repetitive LKE program. So in this example, you can see that we have a construction rental company that has a rental fleet that turns over on a semi-frequent basis. The sales of rental assets in this scenario on an annual basis is $10 million. The average hold time, two years. The average residual is 75%. They are using bonus depreciation, and they have a combined annual fleet growth and inflation of 5%. We will look at what our benefit model calculator spits out related to these facts in a moment, but in general, what you can see is that the deferral is around $6.4 million. I am sorry, the cash tax savings. So that is the deferral, the tax deferral times our 40% is $6.4 million. If you move on to the next slide, what we can see here and what is really important to highlight, you see that 6.4 modeled out, and the period that we, that is a cumulative tax savings, so you can see that we get very quickly to the majority of that tax savings. Within the first four or five years, we have saved $4.5 or $5.4 million associated with this LKE deferral program. The incremental growth we received between years 5 and 10 really relate to the portfolio growth that we have forecasted. One thing I want to talk about here briefly is to the extent you are hearing these things and this sounds like an exciting opportunity, with very few inputs, just those inputs that you saw on the previous slide, slide 21, we could develop this same benefit calculation for you for your specific facts. If that is something that you are interested in after hearing this discussion, we would be really excited to do that. So just give any one of us a call or reach out to us and we would be happy to do that. As we move on to slide 23, we have a little bit more detail or granularity around how we satisfy those tax requirements and what an LKE program might look like. I walked through that briefly, but I will give you the high points here again. So the way we have this diagram set up, we have got certain swim lanes associated with the different parties involved in the process. So clearly at the top we have got our dealer and then we have got PWC and PWC's role as a tax return data provider. We have got the qualified intermediary, we have got the equipment supplier, the OE, and then we have also got the buyer. So in an LKE program, as I was saying, the dealer is still going to sell the equipment directly to the buyer, either through a branch or through auction or through consignment. The key is that we do that assignment of rights in that master exchange agreement before that sale. So we put that contract in place, we have assigned our rights in all future sales in that MEA to the qualified intermediary. So we have satisfied that requirement. You can see that we send, what we are demonstrating here with this dotted line is that we send the buyer notification language in the form of either a purchase order or some other document. We commonly work with auction houses like Ritchie Brothers to make sure if they are doing the sale on our behalf, we are able to get this notification language into some form format in the auction material. That might be in the bidder book, most certainly it would be in the bidder book. It is commonly also on the website so that the buyers have the ability to see that that notification is taking place. Once payment is processed from the buyer, that is sent up to the qualified intermediary which you can see there in the middle holding the funds and then the qualified intermediary is going to disperse those funds for the purchase to our OE. So again you can see here we have already assigned our rights in the master exchange agreement, our rights in that purchase agreement to the OE. We send our purchase order to the OE and the purchase order contains that notification language. The OE sends the equipment directly back to us just like our normal course of business whether that is to a specific branch or whatever location you desire. So that really completes the LKE transaction. Then from a tax reporting perspective we work with the rental company to develop what we call an extract. So when we would spend time with you up front as we are putting these business processes in place, finalizing the MEA, getting that notification language in the documents, working through the cash structure, we would also work with your IT group to get a data file out of your fixed asset or your portfolio management system that is able to give us certain key data points. Nothing that your system wouldn't have, things like asset type, acquisition date, acquisition cost, sales proceeds, sales date, and maybe a couple others. But those are the key fields that we really need. We get that file out of your system and we upload it into our system. Our system is then capable of doing all of the matching, generating reports that go to the QI, running tax depreciation, and also calculating both the realized tax gain and the recognized tax gain. And for most of us, more importantly, that deferred tax gain, which is obviously the difference between the realized and the recognized. So that's the amount that we are going to defer. PwC's system prepares a series of reports that will then help you as the taxpayer or your tax return preparer prepare that annual tax return. And that really is the completion of the LKE program. If we move on to the last slide, I've got a couple other key points that I want to make sure we talk about related to a repetitive LKE program. First, just like I started when I talked about the tax rules and internal revenue code related to 1031 and how that structure with the Qualified Intermediary is really the prescribed methodology provided by Congress, Congress also recognized the need for these program-based solutions. So provided us a revenue procedure that provides several very important safe harbors that facilitate this repetitive LKE program. Maybe the most important is that that account or those accounts that receive these funds are able to be joint accounts that are in the name of both the taxpayer and the Qualified Intermediary. So oftentimes when we work with our clients on this we don't have to create it. Sometimes we create a new account to receive these sales proceeds but other times we look at your existing accounts and we're able to convert or modify those accounts so that they're in the name of both the taxpayer and the Qualified Intermediary. And that makes a real big difference when we go through these processes because we don't necessarily have to change, remit to advice for all of our customers and that can be nice because we don't have to retrain customers. Another important safe harbor is that each transaction, even though we have an LKE program, each transaction really stands on its own. So if for some reason we've got this LKE program in place but cash for some reason goes to the wrong place, you tell a customer to send cash to the QI account but they send it to your general operating account. Well, we've now received those funds and that would most likely disqualify that transaction for LKE treatment but that doesn't mean the whole LKE program is blown up. That would just disqualify that one transaction. Some other things to point out, step in the shoes depreciation is a nice benefit. Essentially what that says is that when I sell that asset in year three, most likely that's a five-year asset and there would be two more years of depreciation if I had held it. Well, you actually do continue to depreciate that asset. So you do depreciate that asset over the full asset depreciation range, the tax life of the asset. Recapture bonus depreciation increases the LKE benefit. As we showed there, the fact that we had bonus actually makes LKE more beneficial because we have a lower tax basis associated with our disposal of assets which would mean without LKE, we've got a very large tax bill to Uncle Sam that we have to pay. The ongoing LKE benefit as long as the tax bearer continues, this is a really important point. For those of you that are familiar with tax accounting principles, light count exchange is considered a timing difference and that means that it is expected that at some point in the future, it will reverse and that you'll have to pay that bill. However, with light count exchange, we actually have a nice nuance. To the extent that you continue to invest in your rental portfolio, you really create what we would call a quasi-permanent benefit, meaning that that timing difference really doesn't reverse until you start to defleet or reduce that investment. And the importance of that is that you should really see this LKE deferral, this tax savings as an interest-free loan from the government and allowing your business to continue to invest in the capital of the business and continue to invest in the things that make you successful as a business. The last point there is one that I already made which is that the LKE system, you know, I think if you get, you know, bogged down in the idea of, well, we're doing 100 transactions a year, that seems daunting but the nice thing is there's a developed automated solution that tracks these LKE transactions, does the matching for you, generates the necessary reports that can go out to the QI and then also the necessary reports to help you to facilitate your tax return process. So all those are also really important points to talk about when we talk about LKE programs. With that, I'm going to turn it over back to Dave who's going to talk about dual-use properties. Thanks, Pat. I guess I'll just remind all the participants if you've got any questions over the materials that we've covered, to this point, you can post those again on the chat screen or, you know, the chat box that you have available. We're down to our last two topics. Pat mentioned dual-use and then we're going to spend just a few minutes covering some of the changes that will be taking place with respect to how to account for leasing or rental activities. While that's not necessarily a tax item per se, it's something that's accounting oriented and we thought the participants would be interested and we think it's something that dealers may be or will be thinking about as it relates to their rental business. The first topic here, dual-use, Pat did a really nice job of sort of talking about congressional intent and, you know, the fact that bonus depreciation, you know, helps to stimulate investment in trade or business property in equipment as it relates to what we're talking about today and then sort of the congressional intent in terms of the pro-growth and economic investment that's kind of driven from like-kind exchange. If we go over to slide 26, I do want to talk a little bit and maybe this is, you know, somewhat of a taxpayer beware sort of situation when we get into this notion of dual-use. And what do we mean by dual-use? You know, as viewed by the IRS, it's equipment that's being held simultaneous for a sale and lease or sale and rent. Again, if we think about how the rental business has evolved for many equipment dealers, you know, dealers, you know, once upon a time, 15, 20 years ago were primarily focused in dealer activity, you know, selling equipment as inventory and, you know, generating income and profits and taxable income as a result of that. Over time, customers have been more interested in renting equipment and, you know, sort of the way that's evolved has created questions in the mind of the IRS in terms of how the tax law should be applied, you know, with respect to treating that equipment as either being primarily held for sale or rent. And why is that an important question? Well, these tax benefits that we've talked about, you know, the benefits of makers and bonus and like-kind exchange, they're really only available if equipment's primarily held for rent and they're not available for equipment that's primarily held for sale. And this sort of, you know, debate or determination on the primary purpose that equipment dealers are holding, you know, that equipment, you know, is something that the IRS has challenged, you know, over the years and it's been an area of controversy, to be quite honest about it. And as the rental businesses of the dealers evolved, you know, many in the industry, you know, including the AED, some of the OEMs, you know, PWC is a tax advisor to the industry. We were involved in IRS examinations. You know, we were involved in a number of different things. But, you know, ultimately, you know, we went to the IRS and said, the industry needs, you know, guidance on this area. You know, we need to, you know, have a better understanding on how this activity's going to be treated. You know, taxpayers need certainty. The business activities have evolved. You know, there's not this notion of simultaneously holding equipment. You know, dealers have, you know, dedicated rental fleets, you know, because of the way that the industry's evolved in customer demands. So there is an active project within the IRS. It was kicked off in 2013. I'll talk in a minute about a notice that was issued. You know, the IRS, you know, doesn't always move quickly. It kicked off in 2013. It has been on their project plan for 2014 and 2015, 2015 and 2016. And, you know, just within the last couple of days, actually, it was also included in the project plan for 2016 and 2017. They, being the IRS, they are making progress on this project. We've met with the AED, with treasury officials. We had meetings, I believe, in March, and then we had some meetings more recently in June so that the industry could provide some input. But the project is advancing, and, you know, I'm keeping my fingers crossed, and we hope that the guidance will be provided shortly. Just by way of a little bit of, you know, background, and, you know, if we look at slide 27, as I'd indicated, this all kicked off when the IRS issued a notice in 2013, and that's notice 2013-13, where the IRS had requested comments from the industry, you know, to help them formulate guidelines that would be useful and effective for the industry. On slide 28, you know, we just note here that the AED did comment, provide comments. Price Waterhouse Coopers did as well, as well as, you know, John Deere and Caterpillar and the North American Dealers Association. If anybody would like to get the notice or those comments, you know, just let us know. We can forward those on to you. I think the main takeaway point here is, you know, just be aware that recordkeeping is important. You know, how you characterize these transactions on your books and records is important. We hope the guidance, when it comes out, will have what I would call sort of a book tax conformity, you know, kind of safe harbor in which the taxpayer will be given the benefit of the doubt if the property is characterized as rental equipment on the books. And then, you know, perhaps that portfolio of equipment on an aggregate basis, you know, would be subjected to some test, you know, maybe involving holding period, number of renters, something like that. But that would be done, we think, within the safe harbor on an aggregate or portfolio basis to just verify the characterization of the equipment that's occurred on the dealer's books and records. But it is something that we still continue to see dealers, you know, have some issues with if the IRS reviews their tax return. And again, you know, recordkeeping and, you know, being able to support the underlying business activity of the equipment that you're renting is important in terms of sustaining your tax depreciation deductions as well as sustaining gain deferral if you're doing like-kind exchange. Lastly, and we're getting close to the top of the hour here, we're going to take a couple minutes. I may run over a couple minutes here and just touch briefly on a new leasing standard. I don't know how many accountants or finance folks we have on the call today, but if that's your area of expertise or kind of your functional activity, you may be aware of the fact that, Craig, if we go to slide 31, you may be aware of the fact that FASB in February this year issued a new lease accounting standard. I've found as I've been out in the industry and kind of talking about, you know, this lease accounting standard and hearing people talk about it, there seems to be maybe some, you know, confusion in terms of ultimately how this new standard ended up. And to a great extent, that's created by the fact that, you know, this project began back in 2006. So maybe the wheels of government don't move all that fast, but the wheels of our standard setters for accounting standards don't always move that fast as well. And there's been a lot of deliberations. There's a lot of been a lot of proposals that have been put on the table over the last 10 years, but the new standard is out. It was originally that the standard setters originally embarked on this because there were concerns about leases being off balance sheet and not visible to readers of financial statements, you know, whether that be shareholders or bankers. You know, really if you go back and, you know, Enron and some of those sorts of things really is what gave rise to the standard setters taking a second look at the old FAS 13 accounting standard for leasing. The new rules for non-public companies, they're not effective until reporting periods ending after December 15th of 2019. So it's still a ways off. You've got time to get up to speed on this. Public companies are required to adopt a new standard a year earlier. Early adoption, if you're so inclined, is permitted. And then I don't know that I have a note here, but, you know, when it is adopted, you have to go back and restate the earlier years. So, you know, there may be some information gathering that would have to be done sooner. The reason we bring it up today is to, you know, one, just to kind of give everybody an update, you know, but also just sort of briefly, you know, address, you know, how this might affect your rental operations. So I'll talk about that here in a minute as well. Just as an overview of the new standard, there's been some changes in terminology, you know, under FAS 13 or the old rules, you know, we had a definition for capital leases and operating leases. I think even historically, you know, some people may have called a capital lease a finance lease, but the new official language now under the new standard is a finance lease and an operating lease. Given all the, you know, kind of changes that occurred over 10 years, this wasn't always the case, but the way the rules, you know, ultimately were finalized, you know, the determination on whether a lease is a finance lease or an operating lease is really not all that much different than what we've had historically. The one change is, and if you're an accounting type, you might be aware of the 75% of the estimated useful life criteria under FAS 13 and the 90% net present value of lease payments as compared to market value. Those bright line, you know, the 75%, the 90%, they're not there anymore, but there's, you know, language there, you know, that talks to, you know, over substantially the expected life and the net present value of payments being, you know, substantially equal. You know, I think everybody thinks that that substantial kind of corresponds to the 75% or 90%, but there is an element of judgment now that wasn't there before. Importantly, as it relates to our discussion today, none of this impacts how you would characterize an asset that's being rented or that you're renting or leasing or that, you know, you may be leasing or that you were leasing to others. None of that affects the tax characterization. These new accounting rules don't affect the tax characterization. So you may have things being treated one way for your books and another way for tax, and, you know, that will still occur in the future. We've slipped a little bit beyond noon, so I'll try to speed things up here. Noon my time, earlier for others, I guess, in the Midwest and on the West Coast. But the big change in this leasing standard, kind of going back to the reason the standard setters started to look at this, you know, this concern about off-balance sheet treatment, under the new rules, all leases, whether they're finance leases or operating leases, will show up on the balance sheet of filers or in the preparation of financial statements. And so, you know, if the term is greater than 12 months, and, you know, I'm spending time talking about this today, but to a great extent, I think, for your rental activities, for your customers, most of the time, I believe, you know, the rental contracts will be for less than 12 months. So there's a carve-out, so to speak, that the new standard won't change the way your customers might have to report their rental activities on their balance sheets. And, you know, to a great extent, I wanted to provide an overview here, but, you know, kind of make this point that for short-term rental contracts, you know, they won't be treated as a lease as it relates to these new rules, you know, the need to put the lease on the balance sheet. Now, just for informational sake, where you do have to put the lease on the balance sheet, again, whether it doesn't matter, finance lease, operating lease, the name of that asset is the so-called right to use, kind of picking up on the whole notion of what a lease is. It's, you know, a contract to use an asset for a period of time. There's a right to use asset that has to be recorded for both operating and finance leases, and there's a lease liability that's recorded as well. This, too, I think, for a lot of folks is kind of a big deal. For an operating lease, you know, they now have to carry a liability on the balance sheet, and, you know, when you get into accounting circles, you know, people talk about what impact that might have on debt covenants, performance ratios, you know, things of that nature, so that's just one more thing to be aware of. As a technical matter, this lease liability is not reported as debt, you know, so that was, you know, a bit of an accommodation on the part of the standard setters, you know, trying to minimize the impact of recording this new liability on filers and with respect to the preparation of financial statements. Just very briefly on the income statement side here, you know, operating leases, the expense associated with an operating lease still is very much the way it was in the past. You know, there's some recharacterization in terms of how you get to that lease expense, but it's essentially, you know, the payment amount, and it gets broken down between interest and amortization of the right-to-use asset, but you get back to the same point. Finance leases, the impact on the income statement is very similar to the old rules, similar to the old capitalized leases. There was kind of a front ending of an expense associated with a finance lease as opposed to an operating lease because you had to both reflect the interest expense on the liability for a finance lease, and you had to amortize the asset that was recorded, and that's, you know, still the case. That's a quick run-through on slide 33. We've just summarized that in a little bit of a matrix here, so that's there for your reference. I think with that, we'll conclude our comments. We thank everybody again for joining. I don't see any questions that have been posted online. You do have our contact information in the materials. I do believe you have the ability to download those materials, so if you have any questions for us after the webinar here, feel free to send us an email or give us a call, and thanks again for joining.

webinar

tax implications

rental businesses

rental fleets

depreciation

like-kind exchange

dual-use property

leasing standards

record-keeping

tax benefits