I was recently meeting in our conference room with HARDI’s financial advisers to discuss investment strategies in light of the tumultuous start to the NYSE’s 2016. Unlike our readers, the assets of trade associations such as HARDI are not tied up in physical inventory but rather in financial reserves that serve two purposes. First and most obvious, it is to protect the organization and its members from a financial disaster by ensuring the availability of operating funds to keep staff employed and the lights on. Second, growth of these reserve assets produces capital that we can reinvest into new initiatives and other growth opportunities. That meeting, however, made me envious of our members whose assets are largely in durable goods that serve physical purposes because our adviser wasn’t delivering much good news about how we were going to grow our financial assets any time soon this year.
While he continued to talk about “corporate paper products” and our domestic/international and large cap/small cap diversification, my mind began to wander across three seemingly unrelated thoughts which I actually believe should be the basis for many HARDI members’ 2016 market growth strategies:
1. Why would I put any contribution to net assets earned this year into such a volatile Wall Street roulette game?
2. Why shouldn’t I be looking for hard investments that can generate more consistent returns?
3. Why is it always so d*&n uncomfortable in this conference room, whether it’s the dead of winter or the peak of summer?
Yes, some have accused me of being slightly ADD, and yes, if I’ve been in a meeting with you, it’s extremely likely that my mind wandered occasionally to seemingly random thoughts during the discussion. However, take solace in knowing that in this case my meeting with our investment adviser did generate a solid plan of attack to present to HARDI’s investment community, while also providing the fertile ground that sprouted this article.
On Dec. 21, 2015, while you were probably scrambling to find those last-minute Christmas gifts, our own Jon Melchi sent a policy alert to all members providing an excellent summary and outline of the federal tax package that had just been enacted. While far from a perfect bill in its entirety, the “Omnibus” was “an absolute victory for HARDI and the small business community,” to quote Mr. Melchi [See his adjoining article.] HARDI members may see benefits from several of the delays and revisions of tax policy relating to the Affordable Care Act, extension of 50 percent bonus depreciation through 2017 and extended tax credits for hiring qualified long-term unemployed individuals. But the real win is for those who sell commercial HVAC and refrigeration solutions if they attack this opportunity strategically.
JON MELCHI’S INSIGHTS
According to a September 2015 CNN Money article, “S&P 500 companies, excluding financial companies, collectively had $1.45 trillion in cash reserves sitting on the sidelines in the second quarter,” according to FactSet. The article continues, “spending by S&P 500 companies – measured by capital expenditures – fell 5.6 percent compared to the same quarter a year ago.” Financial analysts continue a raging debate whether this is the chicken or the egg; in other words, the added cash on hand is roughly equivalent to the cash created by prolonged monetary policy of quantitative easing, but the fact remains that U.S. companies have money to invest but aren’t doing so.
For decades, our industry has questioned and fought against the archaic 39-year depreciation period arbitrarily imposed exclusively on commercial HVAC units. 2016’s roller-coaster start to the financial markets presents a golden opportunity for commercial HVAC professionals thanks to the “omnibus” bill. Section 179 of the U.S. tax code has now been permanently amended to allow for the expensing of HVAC units, and landlords may now depreciate HVAC investments over 15 years. For much of the country that is experiencing modest but consistent growth in commercial construction, the timing couldn’t be better as existing buildings try to keep up with newer and better competitors. The commercial HVAC market has been largely reactionary because most building owners had little financial incentive to invest in major HVAC upgrades unless they were faced with extremely high energy costs or were in the midst of total reconstruction projects. Now, however, the environment finally exists for suppliers and their customers to be aggressive and proactive.
Considering the feeble if not negative returns being generated in the financial markets today, companies could enjoy annualized, double-digit returns from upgrades to today’s extremely efficient and intelligent HVAC systems. Industry can now sell to the CFO instead of procurement or maintenance. Sit down with your engineering and contractor customers to identify the most aged buildings and target their owners. Turn service and routine maintenance calls into meetings about full-system upgrades. Make sure your bidding teams are not playing the same old “let’s just drop the price” game and that they understand that the financials of these investments have completely changed with this stunning reversal of tax policy.
Neither HARDI nor I own the building we occupy, but if we did (and we were a for-profit entity), I think there would have been a commercial HVAC design team in our poorly conditioned meeting room rather than our investment adviser last week. The landscape has changed, so quit navigating it as you used to. Share gains are made and opportunistic markets grow during times of disruption, and now is one of those times.
POLICY NOTE: The IRS is in the process of definitively defining the specific HVAC units covered by this law, so be sure to have your tax and legal professionals review the recent tax code revisions.
Among the items extended permanently:
• Section 179 expensing has been made permanent. Long a HARDI priority, the legislation permanently extends the small-business expensing limitation and phase-out amounts in effect from 2010 to 2014 ($500,000 and $2 million, respectively). It also modifies the expensing limitation by indexing both the $500,000 and $2 million limits for inflation beginning in 2016 and allows for the expensing of air conditioning and heating units (HARDI will be seeking IRS clarification on the HVAC component. Conflicting language shows this immediately applies to portable units, but there is some uncertainty on if it could be extended to ductless or ducted products.
• Permanently allows landlords to depreciate leasehold improvements — alterations in a building to suit the needs of a particular tenant — over 15 years instead of 39 years. The 15-year straight-line-cost recovery period also applies to restaurant and retail renovations.
• For manufacturers, the R&D tax credit is permanent, and makes it more useful for startups. Small businesses with $50 million or less in revenue can claim the credit against their alternative minimum tax liability, and certain small businesses can claim it against their payroll tax liability.
• Permanently extends the rule, reducing to five years (rather than 10 years) the period for which an S corporation must hold its assets following conversion from a C corporation to avoid the tax on built-in gains.
Among the items extended for five years:
• Unfortunately, bonus depreciation did not make the list for permanence. However, the legislation would extend 50 percent bonus depreciation through the end of 2017. Thereafter, the bill provides for 40 percent depreciation in 2018 and 30 percent depreciation in 2019.
• Extends through 2019 the work opportunity tax credit. The provision also modifies the credit beginning in 2016 to apply to employers who hire qualified long-term unemployed individuals (i.e., those who have been unemployed for 27 weeks or more) and increases the credit with respect to such long-term unemployed individuals to 40 percent of the first $6,000 of wages.
Items extended through 2016:
• Section 179D tax deduction for energy-efficient commercial buildings. The baseline standards for Section 179D have been raised to ASHRAE 2007 standards.
• 25(c) tax credit.
• 45(L) credit for energy-efficient new homes. The provision extends through 2016 the tax credit for manufacturers of energy-efficient residential homes. An eligible contractor may claim a tax credit of $1,000 or $2,000 for the construction or manufacture of a new energy- efficient home that meets qualifying criteria.
Affordable Care Act Items:
• The bill suspends the 2.3 percent excise tax on the sale of medical devices in 2016 and 2017. That will save the medical device industry around $3.4 billion, according to the Congressional Budget Office.
• The Affordable Care Act’s 40 percent tax on high-cost health insurance plans will be postponed until 2020 instead of going into effect in 2018. Both business groups and labor unions oppose this so-called “Cadillac tax,” contending it is forcing employers to slash the health benefits they provide to workers in order to avoid the tax.
• The bill also suspends the ACA’s tax on health insurance companies for one year. Many believe this tax hurts small businesses because insurers pass on the cost in the form of higher premiums.