The eagerly awaited proposed regulations (REG-104397-18) under section 168(k) (100 percent bonus depreciation) are out. The IRS has now added Treas. Sec. 1.168(k)-2 as part of the proposed regulations. The proposed regulations largely borrow from the existing rules. However, for the application of the rules to the acquisition of used property, the proposed regulations could require taxpayers to expend significant effort to ensure they are entitled to 100 percent bonus depreciation when structuring transactions.
The proposed regulations apply to property acquired and placed into service after Sept. 27, 2017. For any property acquired prior to Sept. 28, 2017, the prior regulations apply. In order for property to qualify for 100 percent bonus depreciations, property must meet the definition of qualified property, be the original use or acquired used property, satisfy the placed-in-service date, and meet the requirement for acquisition of property.
- Qualified property includes the following categories:
- MACRS property that has a recovery period 20 years or less.
- Qualified property also includes the following types of property that a taxpayer acquires after Sept. 27, 2017 and places into service before Jan. 1, 2018:
- Qualified leasehold improvement property;
- Qualified improvement property under prior definition;
- Qualified restaurant property; and
- Qualified retail improvement property.
- Certain computer software;
- Water utility property;
- Qualified film or television production;
- Qualified live theatrical production; and
- Certain specified plants.
Either qualified property also must have the original use commence with a taxpayer or a taxpayer has to have an eligible acquisition of qualified used property. While the original use standard existed under prior law, the proposed regulations retain this rule, including the 20 percent rule for reconditioned or rebuilt property. The proposed regulations also retain the same rules for fractional ownership property.
What is new however, is the application of 100 percent bonus to used property. In order for taxpayers to qualify for bonus depreciation on used property, a taxpayer cannot have used the property at any time prior to acquisition. Under the guidance, a taxpayer has used the property if a taxpayer, or a predecessor, had a depreciable interest in the property at any time prior to such acquisition. This would allow taxpayers who leased property under a true lease to acquire the property at the end of the lease and still qualify for 100 percent of bonus depreciation. There are anti‑abuse provisions for members of a consolidated group, certain acquisitions pursuant to a series of related transactions, and related parties.
While the placed-in-service dates are relatively straightforward for most fixed assets, there are specific definitions for qualified film, television, or live theatrical productions.
One of the most eagerly anticipated provisions of the proposed regulations is the definition of a written binding contract. These rules apply to all property, including self-constructed property. Remember, in order to qualify for 100 percent bonus depreciation, taxpayers must have acquired the property after Sept. 27, 2017. Under the effective date of section 168(k), taxpayers cannot treat property as acquired after the date a taxpayer enters into a written binding contract for the property. For instance, if taxpayer provides a purchase order that qualifies as a written binding contract under an existing supply agreement on Sept. 1, 2017, but does not take title to the item until Sept. 30, 2017, the property would not qualify for 100 percent bonus depreciation. As you can see, it becomes critically important what constitutes a written binding contract.
The proposed regulations define “written binding contract” as a contract enforceable under State law against a taxpayer, or a predecessor, and does not limit damages to a specified amount. However, if a contractual provision limits damages to an amount equal to at least 5 percent of the total contract price, the proposed regulations will not treat it as limiting damages to a specified amount. While the rule under prior law was similar, that was when most taxpayers wanted a loose standard to continue to qualify for bonus in years where bonus depreciation was set to expire. Making insubstantial changes to a contract will not change the date of acquisition under the written binding contract. The proposed regulations indicate that options and letter of intents are not binding contacts. In addition, the proposed regulations will not treat supply agreements as written binding contracts until a taxpayer provides amount and design specifications under the contract.
There is also a rule that 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.
The proposed regulations eliminate the safe harbor for property produced under a contract. Under the prior rules, taxpayers could treat property produced under a contract as if a taxpayer directly produced the item and the rules included a safe harbor. Under the safe harbor, until the customer incurred 10 percent of the costs, the prior rules did not consider a taxpayer to have begun production. Under the proposed regulations, property produced under a contract is subject to the binding contract rule. For those items truly self-constructed or produced by a taxpayer, a taxpayer would continue to qualify for the 10 percent safe harbor.
What could require considerable attention under the proposed regulations are the acquisition rules in structuring transactions, related party rules, and acquisition and divesture transactions. The general rule is a facts and circumstances approach, but when considering the acquisition of used property, it is important to understand if a taxpayer has ever had a prior depreciable interest in the property.
The IRS is proposing that these regulations will apply to property placed in service after a taxpayer’s taxable year that includes the date of publication of a Treasury decision adopting these rules as final regulations. Pending issuance of the final regulations a taxpayer may choose to apply these proposed regulations to qualified property acquired and placed in service after Sept. 27, 2017, by a taxpayer during taxable years ending on or after Sept. 28, 2017.
For application to pass-through entities, see pass-through alert.
Unfortunately, these proposed regulations were not available when many taxpayers may have filed their tax returns. While the proposed regulations are not binding, for those taxpayers that want to rely upon them may have an opportunity to file a superseding return, amend the 2017 tax return, or file an accounting method change to follow the proposed regulations beginning in 2018 with a historical adjustment. Also, taxpayers will need to give additional consideration to M&A or restructuring transactions to determine if bonus depreciation applies. Taxpayers are encouraged to contact a tax professional to determine the potential impact of the proposed regulations.
Check RSM’s Tax Reform Resource Center for the latest analysis on this and other developments related to tax reform.