Authored by Wendy Landrum, Scott Shavel, Patrick Balthazor and Michael Wronsky
Proposed regulations, released Aug. 3, provide guidance on the changes made to bonus depreciation by the Tax Cuts and Jobs Act (the Act). The proposed regulations affect taxpayers who deduct depreciation for qualified property both acquired and placed in service after Sept. 27, 2017. This Tax Alert highlights some of the guidance issued in the proposed regulations. More comprehensive guidance will be issued at a future date.
The Act modified several bonus depreciation provisions, including those listed below.
- Businesses may take 100 percent bonus depreciation on qualified property both acquired and placed in service after Sept. 27, 2017, and before Jan. 1, 2023.
- Full bonus depreciation is phased down by 20 percent each year for property placed in service after Dec. 31, 2022, and before Jan. 1, 2027.
- Qualified property is defined as tangible personal property with a recovery period of 20 years or less.
- The requirement that the original use of the qualified property begins with the taxpayer was eliminated, as long as the taxpayer had not previously used the acquired property and the property was not acquired from a related party.
- Qualified property does not include property used in providing certain utility services if the rates for furnishing those services are subject to ratemaking by a governmental entity or instrumentality or by a public utility commission, any property used in a trade or business that has floor-plan financing indebtedness or property used in a real property trade or business that makes an irrevocable election out of the interest expense deduction limitation under section163(j).
- The amendments apply to property both acquired and placed in service after Sept. 27, 2017. The acquisition date for property acquired pursuant to a written binding contract is the date of such contract.
- Due to the repeal of the corporate alternative minimum tax, the legislation also repeals the election to claim minimum tax credits in lieu of bonus depreciation for tax years beginning after 2017.
- Qualified leasehold improvement property was removed from the definition of qualified property for property placed in service after Dec. 31, 2017.
Summary of proposed regulations
The proposed regulations provide guidance and clarification of the statutory requirements that must be met in order for depreciable property to qualify under the new bonus depreciation provisions as well as how to determine the bonus depreciation deduction. The proposed regulations update existing regulations in section 1.168(k)-1 by providing a new section at section 1.168(k)-2 for property acquired and placed in service after Sept. 27, 2017.
Depreciable property must meet four requirements to be qualified property:
1. Must be of a specified type
Qualified property must be one of the following:
- MACRS property that has a recovery period of 20 years or less
- Computer software
- Water utility property
- Qualified film or television production
- Qualified live theatrical production
- Specified plant
- Qualified improvement property (QIP) acquired after Sept. 27, 2017, and before Jan. 1, 2018
Note: The proposed regulations do not include rules for QIP acquired and placed in service after Jan. 1, 2018, which as a result of a drafting error, were not assigned a recovery period of 20 years or less by the TCJA and ineligible for bonus depreciation as a result.
2. Original use must commence with the taxpayer or used depreciable property must meet certain acquisition requirements
The proposed regulations retain the original use rules in section 1.168(k)-1(b)(3) and do not provide a date by which the original use of the property must commence with the taxpayer.
In regard to used property, the acquisition of such property is eligible for bonus depreciation if:
- The property was not used by the taxpayer or a predecessor at any time prior to the acquisition,
- The acquisition of the property meets the related party and carryover basis requirements of sections 179(d)(2)(A), (B) and (C) and section 1.179-4(c)(1)(ii), (iii), (iv) or (c)(2), and
- The acquisition of the property meets the cost requirements of section 179(d)(3) and section 1.179-4(d)
Section 1.179-4(c)(2) was modified to provide that any property deemed to have been acquired by a new target corporation as a result of a section 338 or a section 336(e) election will be considered acquired by the taxpayer for the purposes of section 179.
Property is treated as used by the taxpayer or predecessor at any time before its acquisition of the property only if either had a depreciable interest in the property prior to the acquisition, regardless if depreciation deductions were claimed for the property.
Lessees: In the case of a lessee having a depreciable interest in the improvements made to leased property and subsequently the lessee acquires the leased property of which the improvements are a part, the unadjusted depreciable basis of the acquired property does not include the unadjusted depreciable basis of the improvements in determining which property is eligible for bonus depreciation.
If a taxpayer acquires a depreciable interest in a portion of property and subsequently acquires an additional depreciable interest, the additional interest will not be treated as previously used by the taxpayer. However, if a depreciable interest is held, sold and then a depreciable interest in another portion of the property is acquired, the additional interest will be treated as previously used by the taxpayer up to the amount of the portion of the depreciable interest held before the sale.
Consolidated groups: A consolidated group will be treated as having a depreciable interest in property if any current or previous member of the group had a depreciable interest in the property while a member of the group.
In the case of a series of related transactions, the proposed regulations provide that the transfer of the property will be treated as directly transferred from the original transferor to the ultimate transferee, with the relation between the original transferor and ultimate transferee tested immediately after the last transaction in the series.
Partnerships: The proposed regulations provide clarification regarding the application of the bonus depreciation provisions to partnerships including:
- Section 734(b) basis adjustments are not eligible for bonus depreciation because they do not meet the original use or used property requirements, as the partnership will have used the property in question prior to making the distribution giving rise to the adjustment
- Remedial allocations under section 704(c) do not qualify for bonus depreciation, as the underlying property will not meet the used property requirements.
- Bonus depreciation will not be allowed on property contributed to a partnership with a zero adjusted tax basis because, if allowed, the partners would have the opportunity to shift the built-in gain among partners.
- Section 743(b) basis adjustments resulting from the sale or transfer of a partnership interest may be eligible for bonus depreciation if the transaction is between unrelated partners. The regulations take the view that since a section 743(b) adjustment is a partner-specific item, it satisfies the used property acquisition requirements.
- A partner’s basis in property distributed to the partner under section 732 does not qualify for bonus depreciation. The distributions fail to satisfy the original use requirement because the partnership used the property prior to the distribution and is determined by reference to either the partnership’s basis in the property or the partner’s basis in the property, thus failing to satisfy section 179(d)(2)(c) or section 179(d)(3).
3. Must be placed in service by the taxpayer within a specified time period
Qualified property must generally be placed in service by the taxpayer after Sept. 27, 2017, and before Jan. 1, 2027.
4. Must be acquired by the taxpayer after Sept. 27, 2017
The proposed regulations provide the rules applicable to the acquisition date requirements in connection with the effective date and provide that these rules apply to all property, including self-constructed property.
The property must be acquired after Sept. 27, 2017, or pursuant to a written binding contract entered into after Sept. 27, 2017. 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 treated as acquired pursuant to a written binding contract. If the written binding contract states the date the contract was entered into and a closing date, the date on which the contract was entered into is the date the taxpayer acquired the property. A letter of intent for an acquisition is not a binding contract.
In the case of self-constructed property, property manufactured, constructed or produced by the taxpayer, the written binding contract rule does not apply and, in this situation, the acquisition rules are treated as met if the taxpayer begins manufacturing, constructing or producing the property after Sept. 27, 2017. Safe harbor rules are provided to determine when manufacturing, construction or production begins and also guidance related to components of the larger self-constructed property.
The proposed regulations provide rules for making the annual election out of bonus depreciation pursuant to section 168(k)(7) for any class of property placed in service during the tax year. Also provided are the rules for making the election under section 168(k)(10) to apply a 50 percent allowance instead of the 100 percent allowance for qualifying property acquired after Sept. 27, 2017, and placed in service by the taxpayer during its taxable year that includes Sept. 28, 2017. The election under section 168(k)(10) applies to all qualified property. Thus, the election under section 168(k)(10) to apply 50 percent bonus depreciation is an all-or-nothing election. It is applied to all qualifying property or none of the qualifying property, rather than “with respect to any class of property.”
The regulations are proposed to apply to qualified property placed in service by the taxpayer during or after the taxpayer’s tax year that includes the date of publication in the Federal Register (Aug. 8, 2018). Pending the issuance of the final regulations, a taxpayer may choose to apply the proposed regulations to qualified property acquired and placed in service after Sept. 27, 2017, by the taxpayer during tax years ending on or after Sept. 28, 2017.
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