The Internal Revenue Service (IRS) has clarified rules relating to immediate expensing of tangible property investment by businesses. One of the most taxpayer-friendly components of the Tax Cuts and Jobs Act (TCJA) is the enhanced 100% bonus depreciation deduction. Recently published final regulations, along with an additional round of proposed regulations, give taxpayers some clarity for taking advantage of these rules.
High-Level Basics
Under these rules, first-year depreciation deductions increase to 100% for qualified property placed in service through 2022,[1] after which the allowed deduction percentage drops each subsequent year by 20% until 2027. To qualify for 100% bonus depreciation, property generally must: (1) fall within the definition of “qualified property;” (2) be new or acquired used property; and (3) have been acquired and placed in service by the taxpayer after September 27, 2017.
Issue #1: Eligibility of Qualified Improvement Property
Prior to the TCJA, qualified retail improvement property, qualified restaurant property, and qualified leasehold improvement property were depreciated over 15 years under the modified accelerated cost recovery system (MACRS), making them eligible for bonus depreciation.
However, the TCJA now classifies these property types as qualified improvement property (QIP). Because of a drafting error, the 15-year recovery period for QIP didn’t make it into the TCJA’s language. The preamble to the final regulations explains that, until Congress enacts a fix, QIP placed in service after 2017 is subject to a 39-year depreciation period and remains ineligible for bonus depreciation.
Issue #2: Property Used by a Predecessor
The TCJA makes 100% bonus depreciation available for qualified used property that wasn’t used by the taxpayer or a predecessor prior to its acquisition. The final regulations defined the term predecessor used in the original tax law, so any taxpayer who transfers assets in a carryover basis transaction or reorganization, any continuing partnership, and any asset owners who make transfers to estates or trusts should use caution to make sure these definitions do not limit the bonus depreciation benefit available.
There is some good news in this guidance. The final regulations include a safe-harbor lookback period that considers only the five calendar years immediately prior to the year a taxpayer most recently placed a property in service. If the taxpayer and a predecessor haven’t been around for the full five-year safe harbor period, only the number of calendar years since inception should be considered.
Also, the final regulations state that “substantially renovated property” can qualify for bonus depreciation, even if the taxpayer had taken depreciation on the original property prior to the renovation. A property is substantially renovated if the cost of the used parts is less than or equal to 20% of the total cost of renovated property, whether acquired or self-constructed.
IMPORTANT NOTE: Under the proposed regulations, rules can become unwieldy for members of consolidated groups, particularly groups with members who enter or exit during the lookback period. Extreme caution should be used when applying the bonus depreciation rules in these transactions.
Issue #3: Acquisition Dates
As clarified by the new guidance, eligible property must have been acquired after—or acquired according to a written binding contract entered into by the taxpayer after—September 27, 2017. The final regulations provide that the acquisition date under a written binding contract is the latter of:
- The date on which the contract was entered into.
- The date on which the contract is enforceable under state law.
- The date on which all cancellation periods end, if the contract has one or more cancellation periods.
- The date on which all conditions subject to such clauses are satisfied, if the contract has one or more contingency clauses.
The final regulations also state that the property manufactured, constructed, or produced for the taxpayer’s business use by another person under a written binding contract is considered self-constructed property. Such property isn’t subject to the written binding contract rule and thus is eligible for 100% bonus depreciation if manufacturing, construction, or production began after September 27, 2017.
Other Rules
Property that is depreciated under the alternative depreciation system (ADS) generally isn’t eligible for bonus depreciation. The required use of ADS, apart from the actual depreciation calculation, does not render property ineligible for 100% bonus depreciation.[2]
The final regulations are effective for qualified property placed in service during tax years that span September 24, 2019. Taxpayers can elect to apply these final regulations to any property qualified under the TCJA, during tax years ending on or after September 28, 2017, as long as the final regulations are consistently applied.
New Proposed Regulations – Highlights
In addition to the consolidated group rules noted earlier, the new proposed regulations address the definitions of qualified property, the treatment of components of self-constructed property, the application of the mid-quarter convention, and certain exceptions to some final regulation provisions. Taxpayers generally can rely on the new proposed regulations for qualified property acquired and placed in service after September 27, 2017, during tax years ending on or after September 28, 2017, and ending before the taxable year that spans September 24, 2019.
Action Items
As the full impact of the TCJA comes into focus, these bonus depreciation rules could impact your tax filings in unexpected ways. For more information about these final and new proposed regulations and depreciation deductions for your business, other business tax rules, tax preparation, tax planning, or tax advice, contact a PYA executive below at (800) 270-9629.
[1] The 20% per year phaseout reductions are delayed a year for certain property with longer useful lives.
[2] The final regulations clarify that using the ADS to determine the aggregate basis or determine the adjusted basis of a taxpayer’s tangible assets for purposes of allocating business interest expense between excepted and nonexcepted businesses generally doesn’t make the property ineligible.
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