The expansion of the bonus depreciation rules was one of the most significant taxpayer-friendly surprises in the Tax Cuts and Jobs Act (TCJA). The bonus depreciation provision allows a taxpayer to immediately deduct a certain percentage of the cost of qualifying property in the year the property is acquired rather than capitalizing that cost and depreciating it over a period of years.
- Immediate tax deduction equal to 50% of the cost of qualifying personal and real property
- Expired for property placed in service after December 31, 2019 (although the percentage decreased to 40% in 2018 and 30% in 2019)
- Only new property qualified for the deduction
- Immediate tax deduction equal to 100% of the cost of qualifying personal and real property
- Effective for property acquired and placed in service after September 27, 2017; expires after December 31, 2026 (beginning in 2023, the percentage decreases by 20% annually)
- New property qualifies for the deduction, but so does qualifying used property that is acquired and placed in service after September 27, 2017
On August 3, the IRS issued the first set of regulations to implement these expanded bonus depreciation rules. These proposed regulations describe and clarify the statutory requirements that must be met for depreciable property to qualify for bonus depreciation. The regulations also instruct taxpayers how to determine the amount of bonus depreciation and the amount of depreciation otherwise allowable for this property. While the guidance was issued in the form of proposed regulations, taxpayers may rely on these proposed regulations for all assets acquired and placed in service after September 27, 2017.
Unfortunately, nothing in these regulations allows qualified improvement property to be eligible for bonus after December 31, 2017, although the regulations do confirm that certain qualified improvement property placed in service after September 27, 2017, and before January 1, 2018, was eligible for 100% bonus depreciation. A technical correction by Congress will apparently be needed, which is not likely to happen until after the midterm elections. A summary of key items that are included in the regulations is below, with more detailed information and analysis available at Wipfli.com.
- Qualified property
- Property with a tax depreciation life of 20 years or less
- Certain computer software that is depreciated over 36 months
- Water utility property
- Qualified film or television productions and qualified live theatrical productions
- Certain plants
- Qualified used property
- In addition to meeting the requirements above, other rules apply to used property.
- The property cannot have been used by the taxpayer or predecessor at any time prior to the acquisition, meaning the taxpayer could not previously have had a depreciable interest in the property.
- If the taxpayer or predecessor has a partial interest in the property and then acquires an additional interest, that additional interest is eligible for bonus depreciation unless the taxpayer had disposed of that initial interest prior to the current acquisition.
- In another pro-taxpayer move, the proposed regulations allow a taxpayer who purchases property they have been leasing from a third party to claim 100% bonus depreciation on the purchase of that property, assuming all other requirements of the bonus depreciation rules are satisfied. If the taxpayer improved the property while they were leasing it, the improvements themselves will not be eligible for bonus depreciation, but the underlying property will be eligible.
- Anti-abuse rules apply to prevent bonus depreciation on assets acquired from related parties or members of a consolidated group.
- Bonus depreciation cannot be claimed on property that is required to be depreciated using the Alternative Depreciation System (ADS)
- This includes property that is owned or leased by tax-exempt entities, used outside the United States, or financed with tax-exempt bonds.
- This also includes certain property owned by a taxpayer that elects to be a real property trade or business or a farming business to avoid the new 30% limitation on business interest expense. Similarly, it includes property that is owned by a business with floor plan interest that is exempt from the new 30% limitation.
- Rules are provided for partnership-specific transactions
- Bonus depreciation can be claimed on adjustments that increase asset basis when a partnership interest is sold by a partner, but not when a partnership interest is transferred upon death or when a partnership interest is redeemed. This will likely change the structure of many partnership redemptions into proportionate cross-purchases between the departing partner and the remaining partners when the partnership has significantly appreciated assets.
- Bonus depreciation also cannot be claimed on adjustments that increase the partner’s basis in an asset that is distributed to them from the partnership.
- The property must be acquired by the taxpayer after September 27, 2017
- The determination of whether property was placed in service after September 27, 2017, depends on whether the binding contract rules or the self-constructed asset rules apply to the property.
- The binding contract rules state that if property is acquired under a binding contract, the date the taxpayer entered into such contract is the date the taxpayer is deemed to have acquired the property.
- The self-constructed asset rules state that if the taxpayer manufactures, constructs, or produces the property for its own use, then the date that manufacturing, construction, or production begins is the date the taxpayer is deemed to have acquired the property.
- In a significant change from prior law, the binding contract rules are now deemed to trump the self-constructed asset rules when a taxpayer contracts with another party to produce the property on its behalf. Under prior law, the more-taxpayer-favorable self-constructed asset rules would have applied.
These new bonus depreciation rules are much more complex than can be described in this Tax Alert. Wipfli will be evaluating their implications on a client-by-client basis and taking them into consideration for our clients’ third-quarter estimated payments and year-end planning. However, if you have any questions in the interim, please contact your Wipfli relationship executive.