The Tax Cuts and Jobs Act (TCJA) significantly expands bonus depreciation under Section 168(k) of the Internal Revenue Code for both regular tax and alternative minimum tax (AMT) purposes. Now, the IRS has released proposed regulations that clarify the requirements businesses must satisfy to claim bonus depreciation deductions. Although the regulations are only proposed at this point, for tax years ending on or after September 28, 2017, the IRS will allow taxpayers to rely on them for property placed in service after September 27, 2017.
Before Tax Reform
Under pre-TCJA law, businesses could claim a first-year bonus depreciation deduction equal to 50% of the basis of qualifying new (not used) assets placed in service in 2017. The deduction was available for the cost of qualifying new assets, including computers, purchased software, vehicles, machinery, equipment, and office furniture. Used assets did not qualify for the deduction.
Businesses also could claim 50% bonus depreciation for qualified improvement property, generally defined as any qualified improvement to the interior portion of a nonresidential building if placed in service after the building was placed in service. Qualified improvement property costs did not include costs for the enlargement of a building, an elevator, an escalator, or a building’s internal structural framework.
The TCJA allows 100% first-year bonus depreciation in Year 1 for qualifying assets placed in service between September 28, 2017, and December 31, 2022. The bonus depreciation percentage will begin to phase out in 2023, dropping 20% each year for four years until it expires at the end of 2026.
To qualify for 100% bonus depreciation, property generally must:
- Fall within the definition of “qualified property,”
- Be placed in service after September 27, 2017, and before January 1, 2023, and
- Be acquired by the taxpayer after September 27, 2017.
The proposed regulations provide additional guidance on several of these elements.
What Property Qualifies?
Under the proposed regulations, qualified property for bonus depreciation purposes is defined to include:
- Property depreciated under the Modified Accelerated Cost Recovery System (MACRS) that has a recovery period of 20 years or less (generally, tangible personal property),
- Certain computer software,
- Water utility property,
- Qualified film or television productions,
- Qualified live theatrical productions and
- Specified plants.
For 100% first-year bonus depreciation, it also includes qualified improvement property acquired after September 27, 2017, and placed in service before January 1, 2018.
Congress intended for qualified improvement property placed in service after 2017 to have a 15-year MACRS recovery period, which would make it eligible for bonus depreciation. However, due to a drafting error, the 15-year recovery period for qualified improvement property is not reflected in the statutory language of the TCJA. Absent a technical correction to fix this glitch, qualified improvement property placed in service after 2017 has a 39-year MACRS recovery period and, therefore, is ineligible for bonus depreciation.
Qualified property also doesn’t encompass property that must be depreciated under the Alternative Depreciation System (ADS). That includes MACRS nonresidential real property, residential rental property and qualified improvement property held by real estate businesses that elect out of the TCJA’s limit on the business interest deduction.
The proposed regulations detail how taxpayers can elect out of bonus depreciation. They also provide rules for electing 50% bonus depreciation, instead of 100% bonus depreciation, for property acquired after September 27, 2017, and placed into service during the taxable year that includes September 28, 2017.
Is Used Property Eligible?
The proposed regulations provide that the acquisition of used property is eligible for bonus depreciation if the property was not used by the taxpayer or a predecessor at any time prior to acquisition of the property. Property is treated as used by the taxpayer or a predecessor before acquisition only if the taxpayer or a predecessor had a depreciable interest in the property at any time before the acquisition, regardless of whether the taxpayer or predecessor actually claimed depreciation.
Businesses that lease property, therefore, can acquire that property at the end of the lease and qualify for bonus depreciation. If a business has a depreciable interest in improvements made to lease property and subsequently acquires the property, the unadjusted depreciable basis of the property that’s eligible for the additional first-year depreciation excludes the unadjusted depreciable basis attributable to the improvements.
Changes to Partnerships
The proposed regulations clarify issues relating to certain partnership basis questions that were generated when used property became eligible for bonus depreciation. The proposed regulations provide that basis adjustments under Section 743(b) (related to a purchase of a partnership interest, or death of a partner) would be eligible for bonus depreciation, assuming the underlying assets meet all other qualifications of qualified property. Basis adjustments under 734(b) (related to the redemption of a partner in a partnership), however, do not qualify for bonus depreciation.
Determining the Date of Acquisition
The TCJA states that property won’t be treated as acquired after the date on which a “written binding contract” is entered into for the acquisition. The proposed regulations clarify that the closing date, delivery date or other such date is irrelevant when determining the date of acquisition — only the date the contract is entered into matters for this purpose.
Under the proposed regulations, a written contract is binding if it’s enforceable under state law against a taxpayer (or a predecessor) and does not limit damages to a specified amount. A contractual provision that limits damages to at least 5% of the total contract price will not be treated as limiting damages to a specified amount.
A letter of intent for an acquisition is not a binding contact, according to the proposed regulations. Further, supply agreements are not treated as written binding contracts until a taxpayer provides the amount and design specifications of the property.
With various tax reform changes in effect, it is important to review the potential impact of these proposed regulations to be certain your depreciation expense is being optimized. There are still uncertainties, specifically related to Qualified Improvement Property, that still need to be answered. However, these proposed regulations provide many answers to depreciation questions and will allow taxpayers to analyze various planning opportunities now available under the TCJA.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.
Please contact a member of your service team for further discussion.