Final regulations and additional proposed regulations were issued for the first-year 100% bonus depreciation deduction. The 2017 tax law expanded the deduction to 100% for qualified property placed in service before the end of 2022. Generally, the bonus then phases out each subsequent year by 20%, until it sunsets in 2027.
Eligible property generally must:
- Fall within the definition of “qualified property;”
- Be unused property or certain qualifying used property; and
- Be acquired and placed in service by the taxpayer after September 27, 2017.
The guidance addresses several critical issues related to these requirements and includes some changes from the proposed regulations issued in August 2018.
Eligibility of qualified improvement property
Prior to the 2017 law, qualified retail improvement property, qualified restaurant property and qualified leasehold improvement property were depreciated over 15 years under the modified accelerated cost recovery system (MACRS).
The new law classifies all of these property types as qualified improvement property (QIP). QIP generally is defined as any improvement to the interior of a non-residential real property that is placed in service after the building was placed in service. Although Congress intended QIP placed in service after 2017 to have a 15-year MACRS recovery period and, therefore, qualify for bonus depreciation, a drafting error did not make that clear.
In what has been called “the retail glitch,” the 15-year recovery period did not make it into the TCJA’s statutory language. The preamble to the final regulations explains that legislative action is required to remedy this problem. Until then, QIP placed in service after 2017 is subject to a 39-year depreciation period and remains ineligible for bonus depreciation.
Used property questions
The new law expanded the property eligible for bonus depreciation to include certain used property – as long as it was not used by the taxpayer or a predecessor at any time prior to its acquisition by the taxpayer. The final regulations define the term “predecessor” to include:
- The transferor in a transaction subject to rules for tax attribute carryovers in corporate acquisitions;
- The transferor in a transaction in which the transferee’s basis in the asset is determined by reference to the asset’s basis when it was in the hands of the transferor;
- A partnership that is considered “continuing” after a partnership division;
- A deceased person, in the case of an asset acquired by an estate; or
- The transferor of an asset to a trust.
The regulations treat these parties as “predecessors” in order to prevent the abusive churning of assets by taxpayers.
The August 2018 proposed regulations explained that a business has used a piece of property if it or a predecessor had a depreciable interest in the property at any time before acquisition, regardless of whether the taxpayer or predecessor claimed depreciation deductions. However, the regulations also requested comments on whether the regulations should provide a safe harbor as to how many taxable years a taxpayer or predecessor must look back to determine if a depreciable interest existed.
The final regulations include a safe harbor look-back period that considers only the five calendar years immediately prior to the taxpayer’s current placed-in-service year for the property. If the taxpayer and a predecessor have not been around that long, only the number of calendar years they have existed is taken into account.
In addition, the final regulations provide that “substantially renovated property” can qualify for bonus depreciation even if the taxpayer had a prior depreciable interest in it before the renovation. A property is substantially renovated if the cost of the used parts is less than or equal to 20% of the total cost of renovated property, whether the property is acquired or self-constructed.
Date of acquisition issues
Eligible property must be acquired after September 27, 2017. The final regulations provide that the acquisition date 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; or
- The date on which all conditions subject to such clauses are satisfied, if the contract has one or more contingency clauses.
The August 2018 proposed regulations provided that property manufactured, constructed or produced for the taxpayer for use in its business by another person under a written binding contract that was entered into prior to the manufacture, construction or production is acquired according to a written binding contract. Many commenters disagreed with this position, prompting the Treasury Department to reconsider.
Thus, the final regulations provide that such property is self-constructed property. This property type is not subject to the written binding contract rule and is eligible for bonus depreciation if the taxpayer began manufacturing, constructing or producing it after September 27, 2017.
The ADS factor
Property that must be depreciated under the alternative depreciation system (ADS) generally is not eligible for bonus depreciation. Some tax code provisions require the use of the ADS to determine aggregate basis for the purposes of the respective provision — but not for purposes of calculating Section 168 depreciation deductions.
The final regulations state that such requirements to use the ADS generally do not render property ineligible for bonus depreciation. They also clarify that using the ADS to determine the adjusted basis of a taxpayer’s tangible assets for purposes of allocating business interest expense between excepted and non-excepted businesses generally does not make the property ineligible.
Related Read: “ IRS Issues Guidance on New Bonus Depreciation Rules“
The final regulations are effective for qualified property placed in service during tax years that include September 24, 2019 – for calendar year taxpayers that would be the 2019 tax year. You can elect to apply the regulations to qualified property acquired and placed in service after September 27, 2017, or during tax years ending on or after September 28, 2017, as long as all of the rules in the final regulations are consistently applied. Alternatively, you can rely on the August 2018 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 ending on September 24, 2019.
The proposed regulations contain additional rules regarding the definition of qualified property, consolidated groups, the treatment of components of self-constructed property and the application of the mid-quarter convention. They also propose exceptions to some of the final regulations.
For example, the proposed regulations include an exception to the depreciable interest rule for used property when the taxpayer disposes of the property within 90 days of placing it in service. If certain requirements are satisfied, the taxpayer’s depreciable interest in the property during that period is not taken into account when determining whether the property was used by the taxpayer or a predecessor at any time before the taxpayer’s reacquisition of it.
Maximize your depreciation deduction
The final and proposed first-year 100% bonus depreciation deduction regulations may provide you with some unexpected opportunities to claim bonus depreciation. In some cases, it might be worth amending your 2017 and 2018 tax return filings. Contact us to discuss how depreciation deductions can help your business.