Bonus Depreciation Regulations Released
On September 13, 2019, the Treasury Department and Internal Revenue Service issued final and proposed regulations regarding the first-year bonus depreciation deduction under Section 168(k) of the Internal Revenue Code for eligible assets (TD 9874). Section 168(k) was amended by tax reform to increase the bonus depreciation from 50 percent to 100 percent for qualified property placed in service from September 27, 2017, through 2022. The amount of bonus depreciation is then phased down 20 percent over the next four years, sunsetting in 2027. It also removed the “original use” requirement that existed under prior law.
The final regulations clarify the full expensing of bonus depreciation for qualified property as authorized by the 2017 tax reform bill known as the Tax Cuts and Jobs Act (TCJA). The final regulations also adopt the August 2018 proposed regulations with some modifications. In addition, new proposed regulations (REG-106808-19) provide new provisions not addressed previously.
As expected, the final and proposed regulations do not correct the “retail glitch” for qualified improvement property (QIP). Tax reform intended to establish a 15-year cost recovery period for QIP. Due to a drafting error, QIP was never provided the 15-year life. As such, QIP is classified as a 39-year life property, not eligible for bonus depreciation. Treasury has stated that it does not have the power to correct the drafting error; a legislative amendment will be required to rectify the error. The regulations do confirm that QIP placed in service between September 28, 2017, and December 31, 2017, will qualify as 15-year property, which is eligible for bonus depreciation.
The regulations provide much needed guidance and clarity on many provisions, including several issues that taxpayers may wish to consider when filing their 2018 returns. Below are some of the highlights from the regulations.
- Tax reform extended qualified property to used property that wasn’t used by the taxpayer or a predecessor at any time prior to its acquisition. The final regulations define “predecessor” as including:
- A transferor of an asset to a transferee in a transaction to which Section 381(a) applies.
- A transferor of an asset to a transferee in a transaction in which the transferee’s basis in the asset is determined by reference to the basis of the asset in the hands of the transferor.
- A partnership that is considered as continuing under Section 708(b)(2).
- The decedent in the case of an asset acquired by an estate.
- A transferor of an asset to a trust.
- The regulations provide a safe harbor look-back period of five calendar years immediately prior to the taxpayer’s current placed-in-service year of the property to determine whether a taxpayer or predecessor had a depreciable interest in a property prior to acquisition.
- “Substantially renovated property” does not satisfy the original use requirement. The property can qualify if the cost of the reconditioned or rebuilt property is not more than 20 percent of the total cost of the renovated property, whether acquired or self-constructed.
- Using the alternative depreciation system (ADS) to determine the asset basis for GILTI (Section 951A(d)(3)) or FDII (Section 250(b)(2)(B)) deductions will not make the property ineligible for bonus depreciation.
- The regulations provide rules for qualified film, television and live theatrical productions.
Application to Partnerships
The final regulations contain detailed provisions that can have a significant impact on depreciation deductions available to partnerships and their partners.
Date of Acquisition
- The acquisition of property acquired according to a written binding contract is the later of:
- The date on which the contract was entered into.
- The date on which the contract is enforceable under state law.
- The date on which all cancellation periods end, if the contract has one or more cancellation periods.
- The date on which all conditions subject to such clauses are satisfied, if the contract has one or more contingency clauses.
- Property manufactured, constructed, or produced for the taxpayer by another person under a written binding contract that is entered into prior to the manufacture, construction, or production of the property for use by the taxpayer in its trade or business, or for its production of income, is not acquired pursuant to a written binding contract, but rather it is self-constructed property. The acquisition date of the self-constructed property is the date on which the manufacture, construction, or production began.
- The final regulations provide rules similar to those in Section 1.168(k)-1(b)(4), which defines when manufacturing, construction, or production begins, including a 10-percent safe harbor.
Taxpayers should examine the placed-in-service dates to determine if there are opportunities for additional bonus depreciation.
The guidance refers to Revenue Procedure 2019-33, which provides additional time for taxpayers to make or revoke an election for property acquired after September 27, 2017, and placed in service during the taxpayer’s taxable year that includes September 28, 2017, since the August 2018 proposed regulations were released so close to the filing deadline.
The final regulations are effective for qualified property placed in service during the tax year that includes September 24, 2019. Taxpayers may elect to apply the final regulations to qualified property acquired and placed in service after September 27, 2017, or during tax years ending on or after September 28, 2017, if the taxpayer applies the rules in the final regulations in a consistent manner. Alternatively, a taxpayer may apply the August 2018 proposed regulations to qualified property acquired and placed in service after September 27, 2017, in a tax year ending on or after September 28, 2017, and before September 24, 2019.
Floor Financing and Public Utilities
Under tax reform, Section 168(k)(9) provides that assets used in certain trades or businesses (e.g., businesses with floor plan financing and regulated public utilities) that are placed in service in 2018 and later years are not qualified property for bonus purposes. The proposed regulations provide additional clarity, such as:
- A business that leases property to a business under Section 168(k)(9) will remain eligible for bonus depreciation if the other requirements are met.
- Taxpayers may claim bonus depreciation on assets used in trades or businesses under Section 168(k)(9) that are acquired or self-constructed prior to September 27, 2017, under Section 168(k)(2) prior to the 2017 tax reform.
- Provides guidance to determine whether property is primarily used by a regulated public utility.
- Taxpayers with floor plan financing interest will only be prohibited from claiming bonus depreciation if the special rule under Section 163(j) permitting floor plan financing to be deducted is used. If the business interest for that year is less than the Section 163(j) interest expense limitation, then bonus depreciation would be permitted. This is an annual test.
Taxpayers with floor plan financing, such as car dealerships or boat dealerships, should review their Section 163(j) calculations to determine if there are opportunities to now deduct bonus depreciation.
De Minimis Rule for Used Property
Taxpayers acquiring property and then disposing of that property within 90 days of placing that property in service are considered to have no prior depreciable interest in that property. If this property is reacquired by the taxpayer, then this property would be eligible for bonus depreciation. However, bonus depreciation would not be permitted if the taxpayer reacquires the property in the same taxable year in which it was disposed.
Components of Self-Constructed Property
Taxpayers may elect to treat one or more components acquired or self-constructed after September 27, 2017, of certain larger self-constructed property to be eligible for 100-percent bonus where the larger self-constructed property was qualified property under Section 168(k)(2) prior to the 2017 tax reform. The proposed regulations provide the time and manner of making the election and provide examples reflecting these provisions.
This provision could be a significant benefit for affected taxpayers. Taxpayers previously would have taken bonus depreciation under the phased out Protecting Americans from Tax Hikes, or PATH, Act rates for construction that began prior to September 28, 2017, but was completed and placed-in-service in 2018 or 2019.
- For property not acquired pursuant to a binding contract, the acquisition date is deferred until the date that the taxpayer has paid or incurred more than 10 percent of the total cost of the property, excluding land and other preliminary costs.
- Members that left a consolidated group of corporations or who change consolidated groups will not be deemed to have used the property in which the former consolidated group had a depreciable interest, unless that specific member was the holder of that interest.
- A partner is considered to have a depreciable interest in a portion for property equal to the partner’s total share of depreciation deductions allocated to all partners over the total amount of the deductions for the current and prior five tax years.
- The basis of qualified property eligible for bonus depreciation should not be reduced by the allowed or allowable additional first-year depreciation in determining whether the mid-quarter convention applies for the taxable year.
Until final regulations are published, taxpayers may rely on the proposed regulations for qualified property acquired and placed in service after September 27, 2017, during tax years ending on or after September 28, 2017, and to components acquired or self-constructed after September 27, 2017. The taxpayer must apply the proposed regulations in a consistent manner.
The final and proposed regulations provided clarity on several important issues. Because these regulations were issued near the tax filing deadline for 2018, taxpayers should review their depreciation to determine if there are additional opportunities to take bonus depreciation under the new guidance. We anticipate additional guidance on how taxpayers can adopt the clarifications in the final and proposed regulations for tax returns that have already been filed by filing amended returns or requesting a change in accounting method.
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