IRS Issues Final Regulations Providing Guidance on Additional First-Year (Bonus) Depreciation

The IRS issued final regulations (T.D. 9916) providing guidance on additional first-year (bonus) depreciation under Sec. 168(k), which was amended by the law known as the Tax Cuts and Jobs Act, P.L. 115-97.  This Capstan blog includes substantive aspects of the Final Regulations on Bonus Depreciation.  Of the 137 pages of Regulations, the Capstan team summarized what we felt were the most relevant to our clients.

T.D. 9916 provides taxpayers with guidance on issues involving the application of Sec. 168(k) that were not addressed in 2019 final regulations (T.D. 9874). This includes clarifying guidance on the requirements that must be met for property to qualify for the deduction, including used property. The regulations also address recent legislative changes to the depreciation rules for qualified improvement property.

The final regulations provide:

• Rules relevant to the definition of qualified property;
• Rules for consolidated groups;
• Rules regarding components acquired or self-constructed after Sept. 27, 2017, for larger self-constructed property for which manufacture, construction, or production began before Sept. 28, 2017;
• Rules regarding applying the mid-quarter convention, under Sec. 168(d); and
• Changes to the definitions in the 2019 Final Regulations for the terms “qualified improvement property,” “predecessor,” and “class of property.”

The IRS plans to issue procedures for taxpayers to choose to apply the final regulations in prior tax years or to rely on the proposed regulations issued in September 2019.

USED PROPERTY:

1. 5 Year safe harbor:
   • 2019 Final Regulations provides that property is treated as used by the taxpayer or a predecessor at any time prior to acquisition by the taxpayer or predecessor if the taxpayer or the predecessor had a depreciable interest in the property at any time prior to such acquisition, whether or not the taxpayer or the predecessor claimed depreciation deductions for the property.
   • To determine if the taxpayer or a predecessor had a depreciable interest in the property at any time prior to acquisition, the 2019 Final Regulations also provide that only the five calendar years immediately prior to the taxpayer’s current placed-in-service year of the property are taken into account (Five-Year Safe Harbor).
   • The Treasury Department and the IRS intended the “placed-in-service year” to be the current calendar year in which the property is placed in service by the taxpayer. Also, the Treasury Department and the IRS intended the portion of that calendar year covering the period up to the placed-in-service date of the property to be considered in determining whether the taxpayer or a predecessor previously had a depreciable interest.
   • ITEM CHANGED:  Accordingly, §1.168(k)-2(b)(3)(iii)(B)(1) is amended to clarify that the five calendar years immediately prior to the current calendar year in which the property is placed in service by the taxpayer, and the portion of such current calendar year before the placed-in-service date of the property determined without taking into account the applicable convention, are taken into account to determine if the taxpayer or a predecessor had a depreciable interest in the property at any time prior to acquisition (lookback period).
   • ITEM CHANGED:  Section 1.168(k)-2(b)(3)(iii)(B)(1) also is amended to adopt the suggestion of the commenter that each of the taxpayer and the predecessor be subject to a separate lookback period.

2. De Minimus Rule Clarified:
   • Section 1.168(k)-2(b)(3)(iii)(B)(4) of the 2019 Proposed Regulations provides an exception to the prior depreciable interest rule in the 2019 Final Regulations when the taxpayer disposes of property to an unrelated party within 90 calendar days after the taxpayer originally placed such property in service (De Minimis Use Rule).
   • ITEM CHANGED: These final regulations also include additional examples to illustrate the application of the De Minimis Use Rule in these situations and conforming changes to §1.168(k)-2(g)(1)(i) of the 2019 Final Regulations.

3. Partnership Lookthrough Rule:
   • Proposed Regs previously has a Partnership Lookthrough Rule provides that a person is treated as having a depreciable interest in a portion of property prior to the person’s acquisition of the property if the person was a partner in a partnership at any time the partnership owned the property.
   • Provided that the portion of property in which a partner is treated as having a depreciable interest is equal to the total share of depreciation deductions with respect to the property allocated to the partner as a percentage of the total depreciation deductions allocated to all partners during the current calendar year and the five calendar years immediately prior to the partnership’s current year.
   • CHANGED: Treasury Department and the IRS agree with the commenter that the Partnership Lookthrough Rule should be withdrawn. Under these final regulations, a partner will not be treated as having a depreciable interest in partnership property solely by virtue of being a partner in the partnership.

4. Series of Related Transactions:
   • The Proposed Related Transactions Rule generally provides that the relationship between the parties under section 179(d)(2)(A) or (B) in a series of related transactions is tested immediately after each step in the series, and between the original transferor and the ultimate transferee immediately after the last transaction in the series.
   • CHANGED: the Treasury Department and the IRS agree that the Proposed Related Transactions Rule should be simplified. These final regulations provide that each transferee in a series of related transactions tests its relationship under section 179(d)(2)(A) or (B) with the transferor from which the transferee directly acquires the depreciable property (immediate transferor) and with the original transferor of the depreciable property in the series. The transferee is treated as related to the immediate transferor or the original transferor if the relationship exists either immediately before the first transfer of the depreciable property in the series or when the transferee acquires the property.

5. Component Election:
   • Section 1.168(k)-2(c) of the 2019 Proposed Regulations allows a taxpayer to elect to treat one or more components acquired or self-constructed after September 27, 2017, of certain larger self-constructed property as being eligible for the additional first year depreciation deduction (Component Election).
   • Larger self-constructed property that is placed in service by the taxpayer after December 31, 2019, or larger self-constructed property described in section 168(k)(2)(B) or (C), as in effect on the day before enactment of the TCJA, that is placed in service after December 31, 2020, is not eligible larger self-constructed property. Any components of such property that are acquired or self-constructed after September 27, 2017, do not qualify for the Component Election.
   • ITEM CHANGED: These final regulations provide that eligible larger self-constructed property also includes 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 under §1.168(k)-2(b)(5)(iii) of the 2019 Final Regulations (written non-binding contract) and that is entered into prior to the manufacture, construction, or production of the property for use by the taxpayer in its trade or business or for its production of income.
   • ITEM CHANGED: These final regulations remove the requirement that the larger self-constructed property be qualified property under section 168(k)(2), as in effect on the day before the enactment of the TCJA, and instead provide that the larger self-constructed property must be (i) MACRS property with a recovery period of 20 years or less, computer software, water utility property, or qualified improvement property under section 168(k)(3) as in effect on the day before the enactment date of the TCJA, and (ii) qualified property under §1.168(k)-2(b) of the 2019 Final Regulations and these final regulations, determined without regard to the acquisition date requirement in §1.168(k)-2(b)(5), for which the taxpayer begins the manufacture, construction, or production before September 28, 2017.
   • With regard to the taxpayers’ question of whether the larger self-constructed property is the building constructed by the taxpayer or the tangible personal property constructed as part of the building, all tangible personal property constructed as part of that building generally is MACRS property with a recovery period of 20 years or less. As a result, the Treasury Department and the IRS have determined that such tangible personal property is the larger self-constructed property for purposes of the Component Election if the construction of all tangible personal property of the building began before September 28, 2017, and any eligible component of such tangible personal property is eligible for the Component Election. Accordingly, these final regulations clarify that all property that is constructed as part of residential rental property, nonresidential real property, or an improvement to such property, and that is MACRS property with a recovery period of 20 years or less, computer software, water utility property, or qualified improvement property under section 168(k)(3) as in effect on the day before the enactment date of the TCJA, is the larger self-constructed property for purposes of the Component Election.
   • Acquisition Dates:
     • A component acquired pursuant to a written binding contract is determined under §1.168(k)-2(b)(5)(ii)(B) of the 2019 Final Regulations.
     • A component is acquired or self-constructed pursuant to a written non-binding contract, these final regulations provide that the rules under §1.168(k)-2(b)(5)(v) of these final regulations determine the acquisition date of such component or when manufacture, construction, or production of such component begins.
     • Clarifies that these rules apply to property that is self-constructed pursuant to a written non-binding contract, and amend §1.168(k)-2(d)(3) to provide a rule similar to the rule in §1.168(k)-2(b)(5)(v) for property that is described in section 168(k)(2)(B) or (C) and is not acquired pursuant to a written binding contract.

Terri Johnson and Bruce Johnson are available to answer your questions.  Feel free to contact us.