On Dec. 22, 2017, the Tax Cuts and Jobs Act (“TCJA”), modified certain provisions of the Income Tax Code. One of the most significant changes was the ability to expense 100 percent of the cost of certain eligible property in the year it is placed in service. Detailed information on the changes to bonus depreciation under the TCJA is available on our prior Tax Alerts “Changes to Bonus Depreciation under the Tax Cut and Jobs Act.” While this law change was clearly beneficial to many taxpayers, it left taxpayers and their advisors with questions as to how it would apply in certain situations. The proposed regulations just released by Treasury answer many of these questions.
The proposed regulations (REG 104397-18) on Bonus Depreciation were released on August 3, 2018. These proposed regulations clarify a number of issues under Section 168(k), such as the types of property that qualify, the acquisition date and placed-in-service requirements, the time and manner of making certain Section 168(k) elections, and the application of Section 168(k) to certain partnership-related transactions. This Tax Alert provides a summary of these regulations and the clarification they provide.
I. Used Property:
Under TCJA, bonus depreciation is also available not only for brand new property, but also for used property. The Proposed Regulations clarify that used property will qualify for bonus depreciation to the extent such property was not used by the taxpayer or a predecessor at any time prior to such acquisition.
The Proposed Regulations also clarify how the prior-use rule applies to fractional interests in depreciable property. Specifically, the Proposed Regulations distinguish between two different scenarios in which a taxpayer acquires an interest in a portion of property:
- If a taxpayer initially acquires a depreciable interest in a portion of a property (a fractional interest in an airplane, for example) and subsequently acquires an additional depreciable interest in the same property, the additional depreciable interest is not treated as being previously used by the taxpayer by virtue of the taxpayer’s ownership of the first depreciable interest.
- If a taxpayer holds a depreciable interest in a portion of a property, sells such portion or a part of such portion and subsequently acquires a depreciable interest in another portion of the same property, the taxpayer is treated as previously having a depreciable interest in the property up to the amount of the portion for which the taxpayer held a depreciable interest in the property before the sale.
There is also clarification on how 100-percent bonus depreciation applies in various partnership transactions:
- Remedial allocations under §704(c) do not qualify for 100-percent bonus depreciation
- The basis of property distributed under §732 does not qualify for 100-percent bonus depreciation
- Basis adjustments under §734(b) do not qualify for 100-percent bonus depreciation
- However, if a §754 election is in effect, a basis step-up under §743(b) will qualify for 100-percent bonus depreciation if the transaction is between unrelated partners.
II. Placed-in-Service Requirement:
- To be eligible for 100-percent bonus depreciation under TCJA, the asset must be placed-in-service after Sept. 27, 2017 and before Jan. 1, 2027 (Jan. 1, 2028 for long-lived property and aircraft).
- A qualified film or television production is treated as placed in service at the time of release or broadcast.
- A qualified live theatrical production is treated as placed in service at the time of initial live staged performance.
- For a specified plant to be eligible for bonus depreciation, the plant must be planted prior to Jan. 1, 2027 or grafted before Jan. 1, 2027, to a plant that has already been planted.
III. Date of Acquisition Requirement:
To be eligible for 100-percent bonus depreciation under TCJA, the asset must also have been acquired after Sept. 27, 2017. The proposed regulations provide clarity on when a property is considered to have been acquired.
Written Binding Contract:
Property will not be treated as having been acquired any later than the date on which the taxpayer enters into a written binding contract to acquire the property. In other words, if the taxpayer enters into such a contract on Sept. 25, even though the property will not be fully constructed and delivered until after Sept. 27, it is not eligible for 100-percent bonus depreciation. A binding contract is one that is enforceable under state law and that does not limit damages to a specified amount. The Proposed Regulations clarify that:
- Options and letter of intent for an acquisition are not binding contracts
- Supply agreements are not written binding contracts until the amount and design specifications are provided
- Making insubstantial changes to the written binding contract will not change the date of acquisition
- Acquisitions of smaller components of a larger property under a binding contract will not cause the larger property to disqualify for 100 percent bonus, but if the larger property does not qualify for 100-percent bonus depreciation, then none of the components will qualify for 100-percent bonus
- In the case of self-constructed property, regarding property manufactured, constructed or produced for the taxpayer by a third party, the written binding contract rule does apply and whether or not the property qualifies for 100-percent bonus depreciation depends on the date of the written binding contract.
- In the case of self-constructed property, regarding property manufactured, constructed or produced by the taxpayer, the written binding contract rule does not apply. The acquisition rules are treated as met if the taxpayer begins manufacturing, constructing or producing the property after Sept. 27, 2017.
o The Proposed Regulations also provide for a safe-harbor that permits the taxpayer to determine the acquisition date as the date on which more than 10 percent of the total cost of the property has been incurred
o The 10-percent safe harbor rule is eliminated for property produced for/on behalf of the taxpayer
IV. Qualified Improvement Property (“QIP”):
The drafting error that removed the MACRS recovery period specifically applicable to QIP, unfortunately, is not addressed in the Proposed Regulations. For a background on this issue, see “Treatment of Qualified Improvement Property under the Tax Cuts and Jobs Act.”
The Proposed Regulations do provide that “qualified leasehold improvement property,” “qualified restaurant property” and “qualified retail improvement property,” are eligible for Bonus Depreciation if such improvements were acquired by the taxpayer after Sept. 27, 2017 and placed in service after Sept. 27, 2017 and before Jan. 1, 2018.
QIP will revert to 39-year life after Dec. 31, 2017 and will not be eligible for bonus depreciation.
V. Other Items:
- Special rules apply to like-kind exchanges, which are not addressed in this Tax Alert. Please contact us for application of the proposed regulations to like-kind exchanges.
- Taxpayers can elect to claim 50-percent bonus depreciation, in lieu of 100-percent bonus, for qualified property acquired after Sept. 27, 2017. Such election applies to all qualified property and is not available at the asset-class level.
Taxpayers may apply these proposed regulations until the final regulations are issued to qualified property acquired and placed in service after Sept. 27, 2017.
Please contact your GHJ tax advisor (310.873.1600) if you have any questions or wish to discuss the changes in more details.