The IRS has published final regulations (T.D. 9874
), as well as re-proposed and newly proposed regulations (2019 proposed regulations) (REG-106808-19
) that provide guidance to taxpayers regarding the additional first year depreciation deduction under Section 168(k). These regulations include several significant, taxpayer-favorable changes in response to taxpayer comments and questions. They also finalize and clarify many of the rules from the proposed regulations published last year.
The final regulations provide taxpayers with several important new rules and clarifications that are mostly taxpayer-favorable. For example, the final regulations will not make property that is manufactured, constructed, or produced for the taxpayer by another person subject to the written binding contract rules. The regulations proposed last year did not treat such property as self-constructed property, and thus conflicted with prior treatment, creating uncertainty. Additionally, for purposes of determining whether property is eligible as used property, the final regulations include a safe harbor that requires only looking back five years. The regulations also clarify and further define “predecessor,” as prior use by a predecessor can make property ineligible for bonus depreciation. A new safe harbor allows certain reacquired property that has been substantially renovated to be eligible. However, despite clear legislative intent, the IRS declined to make qualified improvement property placed in service after 2017 eligible for bonus depreciation and a 15-year life, which will cause a lot of burden on taxpayers once a technical correction is passed.
The 2019 proposed regulations provide taxpayers with guidance that in many cases was lacking from the prior proposed regulations, or that is substantially different from the original guidance. For example, the regulations propose a very favorable election to treat certain components of self-constructed properties as eligible for 100% bonus depreciation, similar to the 2011 safe harbor. The 2019 proposed regulations also provide rules for the acquisition of substantially all the assets of a trade or business (asset acquisition). The proposed regulations update and clarify certain rules related to used property and prior use for consolidated groups, partnerships and a series of related transactions. Finally, the IRS included industry-specific guidance for taxpayers that are regulated public utilities or that have had floor plan financing. Not all of the rules that are proposed will be welcomed by taxpayers who were looking to the IRS for more favorable guidance and flexibility.
Taxpayers must apply the final regulations to taxable years ending on or after Sept. 24, 2019. Alternatively, they may choose to apply the final regulations in their entirety, or the originally proposed regulations in their entirety, to qualified property acquired and placed in service after Sept. 27, 2017, during taxable years ending on or after Sept. 28, 2017. Pending the issuance of final regulations, taxpayers may rely on the 2019 proposed regulations, in their entirety, for qualified property acquired and placed in service after Sept. 27, 2017, for taxable years ending on or after Sept. 28, 2017. They may also apply the 2019 proposed regulations, in their entirety, to components acquired or self-constructed after Sept. 27, 2017, of larger self-constructed property for which the manufacture, construction, or production begins before Sept. 28, 2017.
Taxpayers should begin to assess the impact of the final and proposed rules for tax years ending on or after Sept. 24, 2019, and also consider whether there are more favorable positions that could be applied to property acquired after Sept. 27, 2017. Taxpayers that want to take advantage of the additional benefits in the regulations may have the option to either file a Form 3115 or an amended return for the prior year to follow the more favorable rules. Those who adopt the new regulations early may find that the acquisition date rules and used property rules could provide additional depreciation deductions, but should carefully weigh the implications of doing so. Not all aspects of the new rules are favorable to taxpayers, and several questions remain unanswered.
The Tax Cuts and Jobs Act (TCJA) amended the allowance for additional first-year depreciation deduction in Section 168(k), increasing the 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 is also allowed for specified plants planted or grafted after Sept. 27, 2017, and before Jan. 1, 2023. It 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).
The TCJA also made substantial amendments to Section 168(k), such as expanding bonus depreciation to certain used property and Section 743(b) adjustments. The IRS issued Prop. Treas. Reg. Sec. 1.168(k)-2 on Aug. 8, 2018 (2018 proposed regulations) to provide guidance for property acquired and placed in service after Sept. 27, 2017 (see our prior coverage
for more details). The 2018 proposed regulations were generally modelled after the existing bonus depreciation regulations applicable to qualified property acquired before Sept. 28, 2017, with changes necessitated by the TCJA, such as new rules for used property to be qualified property. The IRS received comments on the 2018 proposed regulations, and addressed those comments in the preambles to the final and 2019 proposed regulations. Many of those comments resulted in changes that are reflected in the two regulation packages that were recently released.
Changes made in the final regulations
Except for a few significant changes and some other smaller modifications, the final regulations generally adopt the 2018 proposed regulations. The substantive changes generally were taxpayer-friendly and involved the new self-constructed asset rules and rules for determining whether used property is qualified property.
A major area of focus for taxpayers has been self-constructed property. The 2018 proposed regulations provided that for purposes of determining acquisitions dates, property that was constructed, manufactured or produced for the taxpayer by another person was not considered to be self-constructed, and would instead follow the default written binding contract rules for determining the acquisition date. The final regulations reverse that position, and treat such property as self-constructed property, consistent with prior existing regulations. This rule is generally favorable for taxpayers because it simplifies the determination of the acquisition date by allowing taxpayers to apply the 10% safe harbor in determining the date on which the self-constructed property was acquired.
Grant Thornton Insight: Taxpayers that relied on the 2018 proposed regulations may not have the most favorable result for property that was already under contract on Sept. 27, 2017, but was not considered acquired on or before that date under these final regulations. The modifications to the written binding contract rules and self-constructed property rules present an opportunity to re-evaluate assets on which a bonus depreciation rate other than 100% was taken because of the acquisition date rules.
The written binding contract rules under the 2018 proposed regulations created uncertainty in situations in which the contract became binding at a date after signing. For example, commentators questioned whether qualified property acquired under a contract that was signed prior to Sept. 27, 2017, but that became binding after that, qualified for the 100% bonus depreciation rate. The IRS agreed this property should be eligible. Therefore, the final regulations provide that the acquisition date of property is the later of:
- The date on which the contract was entered into
- The date on which the contract is enforceable under state law
- If the contract has one or more cancellation periods, the date on which all cancellation periods end
- If the contract has one or more contingency clauses, the date on which all conditions subject to such clauses are satisfied.
This change adds clarity to the rules for taxpayers that had contracts that were not immediately binding, and should not affect taxpayers that have contracts that are binding on the date on which they are entered into.
Another significant change in the final regulations was the addition of a definition of predecessor for determining whether used property is qualified property. The proposed regulations provided that in order to be qualified property for bonus depreciation, an asset must not have been used by the taxpayer or a predecessor at any time prior to the acquisition. The term predecessor was not used in the statute and had not been previously defined for purposes of the regulations under Section 168(k). Therefore, the IRS has provided that a predecessor includes:
- A transferor of an asset to a transferee in a transaction to which section 381(a) applies
- A transferor of an asset to a transferee in a transaction in which the transferee’s basis in the asset is determined, in whole or in part, by reference to the basis of the asset in the hands of the transferor
- A partnership that is considered as continuing under Section 708(b)(2)
- The decedent in the case of an asset acquired by an estate
- A transferor of an asset to a trust.
The final regulations also add a safe harbor look-back period of five calendar years prior to the current taxable year to determine if the asset was used by the taxpayer or a predecessor. This is an important change for taxpayers that acquire used property. Without a safe harbor, taxpayers would have been required to trace an asset all the way back to when it was new and first placed in service by any taxpayer to determine the asset’s ownership history, and whether or not any of those owners had been the taxpayer or its predecessor. That would have been a significant burden for taxpayers, especially if the taxpayer had multiple predecessors or frequent acquisitions and dispositions of assets.
Lastly, the final regulations expand the used property rules to include that if property was used by a taxpayer or predecessor prior to a substantial renovation, then reacquires it after the renovation, it will not be treated as having had a depreciable interest in the property. Property is substantially renovated if no more than 20% of the total cost of the property is used parts. This rule provides parity between new and used property that has been substantially renovated, and expands the opportunity for taxpayers to claim bonus depreciation on used property.
Grant Thornton Insight: The additional guidance on used property is generally welcome news for taxpayers. Taxpayers relying on the proposed regulations had to find analogous definitions for “predecessor” elsewhere in other code and regulations, which may vary widely depending on the purpose of the other rule. The addition of a bright-line safe harbor look-back period generally reduces the tracking burden that the 2018 proposed regulations would have required. Allowing certain property previously owned, but substantially renovated, to not be considered as previously used expands the opportunity for taxpayers to claim bonus depreciation. Taxpayers that did not calculate bonus on certain used property because of the prior use and predecessor rules may now review those assets under the new rules to determine if they would be eligible for bonus.
The 2018 proposed regulations provided that a Section 743(b) basis adjustment would generally be eligible for bonus depreciation, except for any portion of the basis adjustment that is related to Section 704(c) built-in-gain that is recovered using the remedial method. The final regulations provide an exception to the proposed rule for partnerships that are not publicly traded partnerships. Thus, if a partnership qualifies to apply the exception, the final regulations provide that the entire Section 743(b) basis increase is eligible for the additional first year depreciation.
The following chart summarizes the major changes between the 2018 proposed regulations and the final regulations:
The final regulations also made a number of smaller changes and clarifications to the rules from the 2018 proposed regulations:
- Clarify that Section 336(e) election property does not include dispositions described in Secs. 355(d)(2) or (e)(2)
- Clarify that used film, TV and live theatrical productions are not qualified property due to rules in Section 181
- Clarify that licensees of film, TV and live theatrical productions cannot treat the cost of a license as qualified property due to rules in Section 181
- Clarify that taxpayers required to use the Alternative Depreciation System (ADS) for computing its qualified business asset investment (QBAI) or Section 163(j) interest allocations does not cause property to be ineligible for bonus
- Clarify that property acquired by partnerships with a tax-exempt partner is qualified for bonus except for the tax-exempt partner’s proportionate share
- Clarify that the original lessor in a syndication transaction that subsequently reacquires the property is treated as not previously having a depreciable interest
- Clarify that the liquidating damages rule in determining if a contract is a written binding contract applies to both purchaser and seller
- Modifies the special partnership rule for Rev. Rul. 99-5, Situation 1 transactions to deem the contributing partner to place the property in service prior to contribution
- Modifies the special rule for property acquired and disposed in the same year to also apply to partnership interests and related Section 743(b) adjustments
- Modifies the special rule to provide that if the partnership interest is disposed of in a Section 168(i)(7) transaction, then bonus is allowed and apportioned between transferor and transferee
Several taxpayers asked for relief to make or revoke the various elections allowed under the 2018 proposed regulations. The IRS has previously released Rev. Proc. 2019-33
to address those concerns, and accordingly did not provide new rules in the final regulations (see our prior coverage
for more information).
New rules in the proposed regulations
The 2019 proposed regulations provide several changes from the 2018 proposed regulations that fall into three broad categories: Acquisition date rules, ownership and related party rules for consolidated groups and partnerships and rules for specific industries.
The acquisition date rules in the 2018 proposed regulations addressed acquisitions of property, but were not clear on applying the rules to transactions involving an acquisition of all or substantially all of the assets of a trade or business or property that is not subject to a written binding contract. The 2019 proposed regulations provide that a contract to acquire all or substantially all of the assets of a trade or business is binding only if it is enforceable under state law. Regulatory hurdles and minor terms remaining to be negotiated do not prevent the contract from being binding. The proposed regulations also provide that property not acquired pursuant to a written binding contract is generally considered acquired on the date on which the taxpayer pays or incurs more than 10%of the total cost of the property (similar to the safe harbor for self-constructed property in the final regulations).
The acquisition date rules were also sometimes complicated or difficult to apply to components of self-constructed properties that were under construction on Sept. 27, 2017. The proposed regulations provide an election for components of self-constructed property, similar to the election in Rev. Proc. 2011-26, which allows bonus depreciation on the components acquired after Sept. 27, 2017, related to a property for which the manufacture, construction or production began prior to Sept. 28, 2017. This election must be filed with the taxpayer’s timely-filed tax return for the year in which the property is placed in service.
Grant Thornton Insight:The 2019 proposed regulations provide acquisition date rules that are clarified and more favorable to taxpayers than those in the 2018 proposed regulations. The provision of a component election is especially welcome news to taxpayers that had been requesting treatment similar to Rev. Proc. 2011-26. Taxpayers with asset acquisitions, property acquired that was not pursuant to a written binding contract and/or self-constructed property should review the determinations made on 2017 returns, and about to be made on 2018 returns to see if these rules provide a more favorable answer to their acquisition date questions.
The IRS has proposed additional rules related to used property and prior depreciable interests for partnerships and consolidated groups, property acquired in a series of related transactions and properties only held for a short period of time. The proposed regulations provide that a partner is considered to have a depreciable interest in a portion of property equal to the partner’s total share of depreciation deductions with respect to the property as a percentage of the total depreciation deductions allocated to all partners with respect to that property during the current calendar year and five calendar years immediately prior to the partnership’s current year. This rule is similar to the five-year lookback rule provided in the final regulations, discussed above. Corporations entering or exiting consolidated groups received clarification that the group prior-use rule only applies so long as the consolidated group exists, and that it does not apply to a member that departed the group previously (unless it actually owned the property at some point in time). The IRS has clarified that the rule for a series of related transactions only applies in testing relatedness for the Section 179 tests, and not in the case of a transaction described under Section 168(i)(7). However, such relatedness is generally disregarded for a party that is neither the original transferor nor ultimate transferee if another special rule applies (for example, if such party acquires and disposes of the property in the same year, or if it never places the property into service). Lastly, taxpayers that hold property for 90 days or less and then dispose of it to an unrelated party are not considered to have a prior depreciable interest if they reacquire that same property at a future point in time.
Grant Thornton Insight: While these 2019 proposed regulations may add clarity to the used property requirements, taxpayers may continue to have questions about tracking and documentation necessary to properly take advantage of bonus depreciation. The five-calendar-year rule for partners in partnerships may also be difficult to apply to fiscal year partnerships, because it leaves unanswered several questions about placed in service dates (with or without specified conventions) and any changes in taxable year-end of the partnership (or partner).
Taxpayers that either have assets used in regulated utilities or that have had floor-plan financing interest also received additional guidance in the proposed regulations. Generally, taxpayers in those industries cannot take bonus depreciation on their assets as a result of special rules in Section 163(j). However, if a taxpayer is a lessor of property to either of those trades or businesses, then the lessor is allowed to claim the bonus depreciation as long as the lessor is not in one of those businesses.
Taxpayers that have floor plan financing will also be allowed to annually test whether or not the floor plan financing is “taken into account” in determining whether bonus depreciation is allowed for that taxable year. In making it an annual test, the proposed regulations do not permanently prohibit the bonus depreciation deduction for assets placed in service in future taxable years, but rather may allow or disallow on a year-by-year basis. “Taken into account” for this purpose is determined by computing the Section 163(j) limitation by only including business interest income and 30%of adjusted taxable income (ATI) and comparing that to total business interest expense. If the limitation is in excess of the expenses, then the floor plan financing is deemed to not be taken into account. However, the IRS does not believe a deduction under Section 163(j) is optional, so if a taxpayer has interest expense in excess of the limitation (without regard to the floor plan financing component), then it is deemed to be taken into account, and bonus depreciation denied for the taxable year.
Grant Thornton Insight: The annual test appears to be favorable to taxpayers with floor plan financing. However, a question may arise in tax years beginning after Dec. 31, 2021, in computing the interest limitation. That is because prior to those years, depreciation is generally not taken into account (or added back from taxable income) in computing the ATI limitation. In subsequent years, it is unclear whether the ATI test is computed with or without includable bonus. A taxpayer may find that including bonus would require it to take into account floor-plan financing, which then requires the taxpayer to not use bonus depreciation. That may in turn mean that the actual Section 163(j) limitation (without bonus) does not take into account floor plan financing. However, the treatment of this circular computation situation is not clear in the proposed regulations.
The following is a summary of the major highlights in the 2019 proposed regulations:
Taxpayers should begin assessing the impact of the final regulations and the 2019 proposed regulations not only for tax years ending on or after Sept. 24, 2019, but also to determine if there are more favorable positions that could be applied to property acquired after Sept. 27, 2017. Taxpayers that had large amounts of assets placed in service during years ending on or after Sept. 27, 2017, may see the biggest additional benefit, especially for taxpayers with self-constructed property or who had asset acquisitions of an entire trade or business. Taxpayers that want to take advantage of the additional benefits in the regulations may have the option to either file a Form 3115 or an amended return for the prior year to follow the more favorable rules.
Even though the 2019 proposed regulations may not be finalized and effective until 2020, taxpayers may find that the acquisition date rules and used property rules could provide additional depreciation deductions if applied early.
Taxpayers early implementing the final or 2019 proposed regulations cannot selectively apply the rules, and taxpayers must apply the final regulations for tax years ending on or after Sept. 24, 2019. Not all aspects of the regulations are taxpayer-favorable and answers to some important questions remain unclear, so it may not be in a taxpayer’s interest to adopt the entire regulations early. Taxpayers wanting to comment on the 2019 proposed regulations may do so at any time prior to the regulations being finalized.
For more information contact:
Partner, Washington National Tax Office
+1 202 861 4140
Managing Director, Washington National Tax Office
+1 202 521 1523
Senior Associate, Strategic Federal Tax Services
+1 202 521 1556
Senior Manager, Washington National Tax Office
+1 202 521 1555
Senior Manager, Washington National Tax Office
+1 213 596 6754
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