On August 3, 2018, the IRS issued proposed regulations that clarify the bonus depreciation eligibility of certain property under Section 168(k). Although the regulations aren’t yet final, taxpayers can rely on them for property placed in service after September 27, 2017, and for tax years ending on or after September 28, 2017.
Changes Under Tax Reform
Bonus Depreciation
Recent tax reform legislation, referred to as the Tax Cuts & Jobs Act (TCJA), instituted significant changes to bonus depreciation. Under the new law, bonus depreciation was increased to 100% for property acquired and placed in service after September 27, 2017, and before January 1, 2023—plus an additional year for longer-production-period property and certain aircraft.
The 100% bonus depreciation percentage phases down by 20% per calendar year in taxable years beginning January 1, 2023, reducing to 0% by January 1, 2027. In order to qualify for 100% bonus depreciation, the property can’t have a written binding contract prior to September 27, 2017.
The TCJA also expanded the property eligible for receiving bonus depreciation to include used property, which must be acquired in an arm’s-length transaction—the same requirement as that for new property.
Qualified Improvement Property
Before the TCJA passed, Qualified Improvement Property (QIP) was recovered for more than 39 years and was eligible for bonus depreciation. The conference agreement for the TCJA indicated that the new life for QIP was to be 15 years beginning January 1, 2018. Because bonus depreciation applies to assets with a depreciable life of 20 years or fewer, the TCJA removed the language regarding QIP being eligible for bonus.
Unfortunately, in an apparent oversight, the Internal Revenue Code modifications changing the life for QIP to 15 years weren’t included in the final statute. As a result, QIP remains 39-year property and doesn’t qualify for bonus depreciation until a correction is made to the statute.
Proposed IRS Regulations
Binding Contracts
Prior to the proposed regulations, there was uncertainty regarding the presence of written binding contracts for assets prior to September 27, 2017. These contracts could greatly affect the eligibility of bonus depreciation for assets placed in service after that date—particularly for used assets. The proposed regulations provide the following clarification:
- A contract is considered binding only if it’s enforceable under state law against the taxpayer and doesn’t limit damages to a specified amount.
- Property manufactured, constructed, or produced by another person under a written binding contract is no longer considered self-constructed and is deemed acquired as of the date of the contract.
- Self-constructed property that a taxpayer began manufacturing, constructing, or producing after September 27, 2017, satisfies the written binding contract requirement.
- A letter of intent isn’t a binding contract.
Acquisitions of Used Property
The expansion of bonus depreciation eligibility to include used property required additional clarification that’s provided in the proposed regulations. Taxpayers that acquire used property can’t have used that property at any time prior to the acquisition in order for the property to be eligible for bonus depreciation.
The proposed regulations provide the following guidance for different scenarios as they relate to used property:
- Leased property that’s acquired by the taxpayer at the end of the lease is eligible for bonus depreciation.
- If a taxpayer owns a depreciable interest in a portion of a property and acquires a depreciable interest in an additional portion of the same property, the new depreciable interest is eligible for bonus depreciation. However, if the taxpayer owns a depreciable interest in a portion of a property, sells all or part of the portion of the property, and then acquires a depreciable interest in another portion of the same property, only the excess amount of new basis over the old basis is eligible for bonus depreciation.
- If a member of a consolidated group acquires depreciable property that the consolidated group had a prior depreciable interest in, the property acquired by the member of the consolidated group isn’t eligible for bonus depreciation.
- The proposed regulations also provide specific guidance around related transactions, syndicated transactions, and partnerships—specifically Section 704(c), Section 732, Section 734(b), and Section 743(b).
QIP and Bonus Depreciation
The proposed regulations also state that QIP is eligible for bonus depreciation, but only for improvements placed in service through December 31, 2017. If those assets had a written binding contract prior to September 27, 2017, QIP is eligible for 50% bonus—the percentage available before the TCJA.
If the QIP assets had a written binding contract dated after September 27, 2017, and were placed in service prior to December 31, 2017, the assets are eligible for 100% bonus depreciation.
Bonus Depreciation Elections
The proposed regulations provide rules for making elections regarding bonus depreciation. A taxpayer can elect out of bonus depreciation altogether or can elect to take 50% bonus depreciation instead of 100% for assets placed in service after September 27, 2017, but only during its taxable year that includes September 28, 2017.
Impact on Taxpayers
The TCJA increased bonus depreciation to 100%, enabling businesses to immediately recover the costs of certain types of depreciable property and enhance cash flow. This provides benefits to those businesses making significant investments in their companies—whether through acquiring an existing property, constructing a new building, or purchasing equipment.
Having said that, the proposed regulations are a mixed bag in terms of the benefits to taxpayers. Some provisions are taxpayer friendly and provide tax-savings opportunities for owners of tangible property.
However, the lack of guidance around the eligibility of bonus depreciation for QIP is a problem for businesses that make significant capital investments in their existing properties. As a result, it’s likely a technical correction will be required in future legislation to address the issue.
We’re Here to Help
For more information on how the new tax law or the proposed regulations could affect you and your business, contact your Moss Adams professional or email creditsandincentives@mossadams.com. You can also visit our tangible asset incentive services page or our dedicated tax reform page to learn more.