Final regulations provide guidance regarding bonus depreciation, qualified improvement property
Internal Revenue Code (IRC) Section 168(k) allows for an additional first-year depreciation deduction for the cost of qualifying property in the year the property is placed in service, which is commonly referred to as “bonus depreciation.” The Tax Cuts and Jobs Act (TCJA) made several amendments to Section 168(k), including changes to which property qualifies for bonus depreciation and changes to the applicable bonus depreciation percentage (100% bonus until 2023). In September 2019, the IRS and the Treasury Department issued final regulations that provided guidance in connection with only certain portions of Section 168(k), and proposed regulations addressing issues not covered in the final ones.
On Sept. 21, 2020, they published final regulations that address issues not addressed in the 2019 final regulations; adopt rules contained in the 2019 proposed regulations; and make certain clarifying changes to the 2019 final regulations. Specifically, these 2020 final regulations clarify the definition of “qualified improvement property,” and expand the scope of larger self-constructed property eligible for the “component” election.
The 2020 final regulations are over 100 pages and contain many detailed rules. The following is a summary of some of the key provisions.
The TCJA bonus depreciation (100%) rules apply to eligible property that is both acquired and placed in service after Sept. 27, 2017. If the taxpayer acquired qualified property on or before that date, bonus depreciation would be computed based on the lower bonus percentage that existed prior to TCJA. If property is self-constructed, the “acquisition” date is generally the date on which construction begins or – if the taxpayer elects – the date on which the taxpayer pays or incurs more than 10% of the cost of the property.
'The 2019 proposed regulations contained a “component” rule that would allow TCJA (100%) bonus depreciation on “components” – part of a “larger self-constructed property” as defined in the regulations – where the components were acquired after Sept. 27, 2017, but the “larger self-constructed property” was acquired (or construction began) on or before Sept. 27, 2017.
The IRS and Treasury received numerous comments in connection with the definition of “larger self-constructed” property, and the new final regulations clarify and expand the definition of “larger self-constructed property” that is eligible for the election. Specifically, the final regulations now include in “larger self-constructed property” property acquired under a contract that is not a binding contract. They further provide that the larger self-constructed property must generally be “MACRS [Modified Accelerated Cost Recovery System] property with a recovery period of 20 years or less, computer software, water utility property, or qualified improvement property.” As it relates to buildings, the regulations clarified that “larger-self constructed property” is not the building, but includes all tangible personal property and qualified improvement property constructed under that contract.
The TCJA contained drafting errors that prevented taxpayers from recognizing bonus depreciation in connection with qualified improvement property (QIP) placed in service on or after Jan. 1, 2018. This drafting error was fixed in the Coronavirus Aid, Relief, and Economic Security (CARES) Act in March 2020. Additionally, the CARES Act amended Section 168(k) to clarify that the QIP rules did not apply to acquired QIP, but only to QIP that was constructed by the taxpayer (including QIP that was constructed for a taxpayer under a contract).
The 2019 final regulations provided rules interpreting the pre-CARES Act version of the QIP rules. Those regulations clarified that QIP that was acquired by a taxpayer after Sept. 27, 2017, and placed in service by a taxpayer after Sept. 27, 2017, and before Jan. 1, 2018, is eligible for pre-TCJA bonus depreciation.
The new final regulations update the QIP rules to reflect the changes made by the CARES Act. Specifically, they provide that to be QIP, the property must have been constructed by the taxpayer (or for the taxpayer under a contract). However, if a taxpayer acquires nonresidential real property that includes an improvement previously placed in service by the seller, the improvement is not considered to be made by the acquiring taxpayer, and no part of that acquired property may be treated as QIP by the acquirer.
The new final regulations also:
1. Outline specific rules for consolidated groups and certain transfers of qualified property within them.
2. Clarify the Five-Year Safe Harbor rule (related to prior ownership of qualified property).
3. Withdraw the Partnership Lookthrough Rule, and as a result, “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. Clarify rules around Section 168(k)(9), which provides that certain businesses with floor plan financing indebtedness, such as motor vehicle dealerships, cannot claim bonus depreciation on certain assets.
5. Provide that, “for the purpose of determining whether the mid-quarter convention applies, depreciable basis is not reduced by the amount of bonus depreciation.”
Certain topics were not addressed by these new final regulations, such as the operation of bonus depreciation with respect to Section 743(b) adjustments after transfers of partnership interests, which the IRS determined was outside of the scope of the new final regulations.
Applicability date: The IRS said in a release that they plan to issue procedural guidance for taxpayers to choose to apply the new final regulations in prior tax years or to rely on the proposed regulations issued in September 2019.
Richard Shevak, JD, Principal, National Tax
Travis Butler, Director, National Tax
Timothy McMillan, CPA, Manager, National Tax
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