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IRS releases proposed bonus depreciation regulations

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businessman giving or paying money us dollar billsThe IRS has proposed new regulations (REG-104397-18) that provide guidance regarding the additional first-year depreciation deduction under Section 168(k). The proposed regulations reflect changes made by P.L. 115-97, commonly referred to as the Tax Cuts and Jobs Act (TCJA) and affect taxpayers with qualified depreciable property acquired and placed in service after Sept. 27, 2017.

The IRS allows taxpayers to rely on these proposed regulations, pending the issuance of final regulations, for qualified property acquired and placed in service after Sept. 27, 2017, for taxable years ending on or after Sept. 28, 2017, and ending before the taxable year that includes the date when the final regulations are published in the Federal Register.

Background Section 168(k) was first enacted by the Job Creation and Worker Assistance Act of 2002 (P.L. 107-147), allowing an additional first-year depreciation deduction in the placed-in-service year of qualified property. Subsequent amendments modified the percentage of the additional first-year depreciation deduction, among other changes.

On Dec. 22, 2017, the TCJA amended the allowance for an additional first-year depreciation deduction in Section 168(k), increasing the additional first-year depreciation deduction percentage (or bonus depreciation percentage) from 50% to 100% for qualified property acquired and placed in service after Sept. 27, 2017, and before Jan. 1, 2023 (or before Jan. 1, 2024, for longer-production-period property (LPPP)). The 100% bonus depreciation percentage is also allowed for specified plants planted or grafted after Sept. 27, 2017, and before Jan. 1, 2023. The 100% bonus depreciation percentage is decreased by 20% annually for qualified property placed in service, or specified plant planted or grafted, after Dec. 31, 2022 (or after Dec. 31, 2023 for LPPP,).

Prior to the TCJA, qualified property eligible for bonus depreciation included certain Section 168 property with a recovery period of 20 years or less, certain computer software, water utility property, and qualified improvement property, the original use of which begins with the taxpayer. The TCJA expanded property eligible for bonus depreciation to include certain used depreciable property, including certain film, television, and live theatrical production property.

Treas. Reg. Sec. 1.168(k)-1 describes and clarifies the statutory requirements for depreciable property to qualify for bonus depreciation under former Section 168(k). Because the TCJA made substantial amendments to Section 168(k), Treas. Reg. Sec. 1.168(k)-2 updates the existing regulations for property acquired and placed in service after Sept. 27, 2017.

Qualified improvement property For property acquired and placed in service after Sept. 27, 2017, and before Jan. 1, 2018, the proposed regulations provide that qualified leasehold improvement property (QLIP), qualified restaurant property (QRP), qualified retail improvement property (QRIP), and qualified improvement property (QIP) continue to be bonus-depreciation eligible, pursuant to the TCJA.

For property placed in service after Dec. 31, 2017, the TCJA eliminated the 15-year modified accelerated cost recovery system (MACRS) property classification for QLIP, QRP, and QRIP. The statutory text of the TCJA, however, assigned a 39-year recovery period to QIP while also eliminating QIP as a specific category of qualified property for bonus depreciation. The conference agreement for the TCJA states that QIP was intended to have a 15-year recovery period, which would have made it eligible property for bonus depreciation.

The proposed regulations do not follow the conference report in that they do not allow bonus depreciation for QIP that is placed in service after Dec. 31, 2017. The preamble to the proposed regulations does not reference the legislative history, and it appears that a technical correction to the statute is necessary with respect to QIP.

Grant Thornton Insight: It is unclear when and if Congress will pass a technical corrections bill. The IRS had said informally that it would not incorporate the impact of technical corrections in any formal guidance until an actual technical corrections bill is passed. This will likely cause taxpayers to amend tax returns if and when the technical corrections bill is ultimately passed.

Used property The proposed regulations generally retain the existing rules with respect to new property and provide new rules for applying bonus depreciation to acquisitions of used property. The proposed regulations provide that the used property must not have been used previously by the taxpayer (or predecessor) and is not acquired from a related party or in certain tax-free transactions. The regulations provide a special rule for consolidated group members.

The proposed regulations define “use” as having a depreciable interest in the property. The proposed regulations provide some helpful examples of how to apply this test. For example, if a taxpayer initially acquires a depreciable interest in a portion of an asset and subsequently acquires an additional depreciable interest in the same property, the proposed regulations provide that the additional depreciable interest is not treated as being previously used by the taxpayer. Additionally, if a lessee acquires the property being leased, the additional basis acquired (over the lessee’s own improvements to the property) may be eligible for bonus depreciation. The proposed regulations make it clear that assets acquired in Section 338 and Section 336(e) transactions may be eligible for bonus depreciation.

Grant Thornton Insight: The ability to take bonus depreciation on used property may become a significant factor in merger and acquisition transactions and lease-versus-buy decisions. The anti-churning rules appear to require a significant tracking burden whenever property is disposed to ensure that neither the taxpayer, a related party, nor a successor takes bonus depreciation if the property is subsequently reacquired.

Qualified property requirements table

Application to Section 168(i)(7) and certain partnership transactions The proposed regulations make limited changes to the treatment and allocation of bonus depreciation in the context of certain partnership transactions and transfers described in Section 168(i)(7).

Treas. Reg. Sec. 1.168(k)-1 includes a rule that any increase in basis due to a Section 754 election does not satisfy the original use requirement, and therefore any such adjustment does not qualify for bonus depreciation. Because the TCJA removed the original use requirement, the IRS reconsidered the application of bonus depreciation in the context of basis adjustments under Sections 743(b) and 734(b), as well as certain Section 704(c) allocations and distributions of property as they relate to basis under Section 732.

The proposed regulations allow bonus depreciation only for certain Section 743(b) adjustments, which are generally those made in the transfer of a partnership interest by sale, exchange or death of a partner. In doing so, the IRS takes the view that each partner owns and uses the partner’s proportionate share of partnership property. If such a transfer is between related parties, or if the transferee had previously used the transferor’s portion of partnership property, then the Section 743(b) adjustment does not qualify for bonus depreciation.

A partnership may choose to make Section 704(c) remedial allocations when a portion of a partnership’s book basis in contributed property exceeds its adjusted tax basis. Since the property is contributed to the partnership in a Section 721 transaction, and the basis is determined in whole or in part by reference to the contributing partner’s basis in the property, the rules of Section 179(d)(2) are violated. The preamble states that, in addition, the partnership already had a depreciable interest in the property, thus violating Section 168(k)(2)(e)(ii)(l) and the original use requirement. Therefore, such allocations do not qualify for bonus depreciation. The same rule applies in the case of revaluations of partnership property (reverse Section 704(c) allocations). Also, the proposed regulations do not allow a partnership using the Section 704(c) traditional or traditional-with-curative-allocation methods to take the additional first-year depreciation for zero-basis property that is contributed to a partnership (or revalued by a partnership) due to a potential for built-in gain to be shifted among the partners.

Property distributed by a partnership to a partner in a non-liquidating distribution for which Section 732(a)(1) applies fails to satisfy the original-use requirement because the partner is considered to have used its pro rata share of the partnership property. Similarly, any portion of basis determined by Section 732(a)(2) or (b) fails because the basis is determined in whole or in part by reference to the distributee partner’s basis in its partnership interest. Therefore, such transfers do not qualify for bonus depreciation.

Section 734(b) adjustments may be made to the basis of remaining partnership property after a distribution of property to a partner. Because the adjustment is made to the partnership’s basis in property that the partnership has previously used, it neither meets the original-use nor the used-property requirement in the statute. Therefore, such adjustments do not qualify for bonus depreciation.

The proposed regulations continue to allocate bonus depreciation on property acquired in the year of a technical termination of a partnership under Section 708 to the newly formed partnership, unless such partnership disposes of the property in the year it is placed into service, then no bonus depreciation is allowed. This rule only applies for partnership tax years beginning on or before Dec. 31, 2017, after which technical terminations of partnerships are not applicable.

A special rule for bonus depreciation in transfers described in Section 168(i)(7), generally nontaxable contributions and distributions, continues to allocate such bonus depreciation pro rata, by months, between the transferor and transferee. However, if the property is transferred in a Section 721 transaction in the same taxable year when one of the other partners previously had a depreciable interest in the property (e.g., Rev. Rul. 99-5, Situation 1 transaction), then there is a narrow rule that may require bonus depreciation to be allocated solely to the transferor, and not to the partnership.

Grant Thornton Insight: While the proposed regulations closely follow prior rules in applying bonus depreciation to partnership basis adjustments and transfers described in Section 168(i)(7), taxpayers should be made aware of the changes made because of the TCJA. The application of bonus depreciation to Section 743(b) adjustments may alter the purchase price of such an interest, and taxpayers should be aware that bonus is required to be calculated on such adjustments unless making an election out. Additionally, as noted below, the proposed regulations add a new election out of bonus depreciation for Section 743(b) adjustments, which will create more opportunities, but also may create inadvertent foot faults.

Transaction table

Elections The proposed regulations clarify the elections available to all taxpayers regarding bonus depreciation. The elections specified in the regulations are not related to new elections allowable under Section 163(j) relating to interest expense limitations that may impact the property that is qualified for bonus depreciation.

There continues to be an election out of bonus depreciation available to taxpayers that is generally made on a class-by-class basis. For purposes of this election, an asset class is as defined in Section 168(e). There is no AMT adjustment regardless of whether the taxpayer elects out of bonus depreciation.

Because Section 743(b) adjustments may now be eligible for bonus depreciation, the proposed regulations add a new election out of bonus depreciation for Section 743(b) adjustments. The election out of bonus depreciation for a partner’s Section 743(b) adjustments is made independently from the election out of bonus depreciation for the partnership’s tax basis in the property.

The regulations provide a transition election whereby taxpayers may elect for all property placed into service in the first year ending after Sept. 27, 2017, to apply 50% bonus instead of 100% bonus on qualified property. This election is not made on a class-by-class basis. It does allow some consistency to planning for taxpayers for the 2017 tax year. A similar election was allowed for the first year ending after Sept. 10, 2010, which was the last time that bonus depreciation was temporarily set at a 100% rate.

Elections table

For more information contact: Sharon Kay
Partner, Accounting Methods
Washington National Tax Office
+1 202 861 4140

John Suttora
Managing Director, Accounting Methods
Washington National Tax Office
+1 202 521 1523

Caleb Cordonnier
Manager, Accounting Methods
Washington National Tax Office
+1 202 521 1555

Debbie Shi
Manager, Accounting Methods
Washington National Tax Office
+1 202 521 1501

Grace Kim
Principal, Partnerships
Washington National Tax Office
+1 202 521 1590

Jose Carrasco
Senior Manager, Partnerships
Washington National Tax Office
+1 202 521 1552

Ryan Nodal
Manager, Partnerships
Washington National Tax Office
+1 202 861 4111

Whit Cocanower
Senior Associate, Partnerships
Washington National Tax Office
+1 202 521 1501



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