The IRS has released final regulations (T.D. 9916) for bonus depreciation under Section 168(k) that provide substantially modified guidance from the proposed regulations issued in September 2019 for partnerships, consolidated groups and taxpayers that undertake a series of related transactions. The final regulations also provide clarifications and examples for other special rules.
The Tax Cuts and Jobs Act (TCJA) made substantial amendments to Section 168(k), such as expanding bonus depreciation to certain used property and Section 743(b) adjustments. In response to comments received from taxpayers, the IRS issued the 2019 proposed regulations to provide safe harbors for prior use and predecessors, rules for consolidated groups and partnerships and a component election for projects that began before Sept. 28, 2017, but were placed in service after that date.
The final regulations address comments and concerns on the 2019 proposed rules, and make several changes, including clarifications and substantial modifications. However, additional procedural guidance may be required for taxpayers that implemented the 2018 and 2019 proposed bonus deprecation regulations to adopt the final rules. These taxpayers should assess their ability to take advantage of any favorable changes when such guidance is issued. Taxpayers should also carefully weigh the benefits of adopting the final regulations against the 2019 proposed regulations for tax years ending before Jan. 1, 2021.
Partnership look-through rule
Under the 2019 proposed regulations, a partner would have been considered to have a depreciable interest in partnership property that was generally based on the partner’s total allocated share of depreciation deductions for that property during the current and previous five calendar years. By attributing a depreciable interest in a partnership’s property to its partners, this partnership look-through rule would have limited the availability of bonus depreciation for basis increases arising from a variety of transactions involving partnerships, while also imposing significant administrative and compliance burdens on both taxpayers and the IRS.
The final regulations rescind the proposed partnership look-through rule, and as a result, provide that a partner will not be treated as having a prior depreciable interest in partnership property solely by the reason of being a partner in a partnership. The IRS did not replace the rule because it believes that the related party rule under Section 179(d)(2)(A), in conjunction with the series of related transactions rule in Treas. Reg. Sec. 1.168(k)-2(b)(3)(iii)(C) should prevent potential abuse, while limiting the administrative burden.
Taxpayers that choose to apply the 2019 proposed regulations for a taxable year beginning before Jan. 1, 2021, are not required to apply the partnership look-through rule for such taxable year. Regardless of whether the 2019 proposed regulations are applied, the withdrawal of the partnership look-through rule removes a significant obstacle to current or former partners claiming bonus depreciation for property acquired in a variety of partnership transactions.
Series of related transactions
The 2019 proposed regulations provided that for a series of related transactions, in general, the relationship between the parties under Sections 179(d)(2)(A) or (B) is tested immediately after each step in the series, and between the original transferor and the ultimate transferee immediately after the final transaction in the series of transactions. The final regulations expand upon that rule and provide that each transferee must test its relationship with the transferor from which the transferee acquires the depreciable property and additionally must test its relatedness with the original transferor. If the transferee is related to either its immediate transferor or the original transferor, then the transferee would be ineligible for bonus depreciation on otherwise qualified property.
Further, the final regulations provide that if a party in a series of related transactions ceases to exist prior to the completion of the series of transactions, such party is deemed to still exist for purposes of testing relatedness. Alternatively, the final regulations also provide that if a transferor comes into existence during a series of transactions, such transferor must test its relatedness with the original transferor. Consequently, each transferee must test its relatedness with its immediate transferor and with the original transferor, regardless of whether it is formed or dissolved during the series of transactions.
Certain requirements in the 2019 final regulations for used property to be eligible for bonus depreciation raised additional concerns for consolidated groups, including the “no prior use” requirement, related party requirement, the requirement that basis of the used property is not determined in whole or in part by reference to the adjusted basis of the transferor.
The final regulations significantly modify the 2019 proposed regulations and provide new regulations under Treas. Reg. Sec. 1.1502-68 for both the no prior use requirement and the related party requirement. They clarify that the lookback period for the no prior use requirement is five years and additionally clarify the treatment of a series of related transactions involving both an asset acquisition and acquisition of stock of a member.
The IRS also removed the related party requirement, including the 90-day timing for the departure of the buying member of the group in favor of a new construct. Instead, the final regulations adopt a “delayed bonus” approach that has no such timing requirement, but has a simplified construct to allow bonus depreciation while not otherwise opening the door for other “new property” credits or incentives. The delayed bonus approach treats the transferee member as 1) selling the eligible property to an unrelated third party one day after the deconsolidation date for an amount equal to the member’s basis in the eligible property at such time, and then 2) acquiring identical, but different, eligible property from another unrelated third party for the same amount (deemed sale and purchase of eligible property). Taxpayers may elect out of the delayed bonus approach on a timely filed, original tax return.
The 2019 proposed regulations provided a component election allowing a taxpayer to elect to treat components of a larger self-constructed property that were acquired or self-constructed after Sept. 27, 2017, as being eligible for bonus depreciation if the larger constructed property was acquired before Sept. 28, 2017. They further provided that in order to make the election, the larger self-constructed property must be qualified property under Section 168(k)(2).
The final regulations expand the self-constructed property that is eligible for the component election by including property that is manufactured, constructed or produced for the taxpayer by another person under a written contract that does not meet the definition of a binding contract provided under Treas. Reg. Sec. 168(k)-2(b)(5)(iii) of the 2019 final regulations and that is entered into before the manufacture, construction or production of the property commences.
The final regulations also expand on the definition of qualified property under Section 168(k)(2) to include qualified improvement property under Section 168(k)(3) as in effect on the day before the date of the TCJA, but determined without the acquisition date requirement provided in Treas. Reg. Sec. 1.168(k)-2(b)(5). The final regulations, however, clarify that this exception does not apply to a qualified film, television or live theatrical production. The IRS also removed the Dec. 31, 2019, placed-in-service date requirement, such that the date on which the larger self-constructed property must be placed in service by the taxpayer to be eligible for bonus depreciation now aligns with the placed-in-service dates found under Section 168(k)(6).
Clarifications and definitions
The final regulations add the following clarifications to the 2019 proposed regulations.
Five-year safe harbor for prior use of property
The lookback period includes the portion of the calendar year covering the period up to the placed-in-service date and prior five calendar years. Additionally, each of the taxpayer and the predecessor are subject to a separate lookback period.
Floor plan financing
A trade or business with floor plan financing does not have the option to forgo its interest deduction in order to claim bonus depreciation. The IRS is expected to issue further guidance for taxpayers that treated the limitation as optional.
De minimis use rule
The 90-day de minimis rule would apply in a situation where a taxpayer acquires property in year one, uses it for less than 90 days, disposes of it to an unrelated party and subsequently reacquires the same property in year one. The taxpayer is eligible for bonus depreciation upon the reacquisition.
Election not to apply bonus depreciation
For Section 743(b) adjustments, the final regulations clarify that an election under Section 168(k)(7) is made by the partnership for each partner’s basis adjustment for each classes of property.
The final regulations will be effective 60 days after they get published in the Federal Register. Taxpayers have the option to apply the final regulations in their entirety to taxable years ending after Sept. 27, 2017, but once applied, must continue to use them for all subsequent years. Alternatively, taxpayers that have relied on the 2019 proposed regulations may continue to apply the 2019 proposed regulations to tax years ending before the first taxable year that begins on or after Jan. 1, 2021, except for the Partnership look-through Rule, which has been withdrawn.
Taxpayers that implemented the 2018 or 2019 proposed regulations, or the 2019 final regulations may still need certain procedural guidance to adopt these final regulations. Additionally, there continue to be issues that will need to be addressed, such as making a late component election, and relief for taxpayers that chose to voluntarily forego interest deduction in favor of claiming bonus depreciation. Taxpayers should consider the impact of these final regulations and assess their ability to take advantage of any favorable changes when procedural guidance is issued. They should also compare the impact of using the final regulations or 2019 proposed regulations for tax years ending before Jan. 1, 2021.
Partner, Washington National Tax Office
Sharon Kay is the National Managing Partner of Grant Thornton LLP's Washington National Tax Office. Sharon has over 25 years of tax experience and primarily advises clients on federal income tax issues such as accounting method changes, income and expense recognition, inventories, tangible and intangible asset capitalization and recovery, and certain business credits.
Washington DC, Washington DC
- Strategic federal tax
Practice Leader, Tax Technical, Washington National Tax Office
Grace Kim has more than 20 years of experience in the area of partnership taxation, which includes IRS, law firm and accounting firm positions. Her diversified experience includes working on a broad range of structuring and operational issues in a variety of industries and areas.
Washington DC, Washington DC
- Real estate and construction
- Private equity
- Strategic federal tax
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