Perhaps one of the most recognizable changes in the newly-reformed tax code is the temporary increase in additional first-year depreciation allowance (or “bonus”) from 50 percent to 100 percent of the asset’s cost. In the weeks since tax reform became law, many taxpayers have already begun planning for the current tax savings they might see from full expensing. Before finalizing any such plans, however, taxpayers need to be aware of two lesser-known rules that may prevent certain property from qualifying for 100 percent bonus, even with a qualifying placed-in-service date.
Acquisition date
Generally, a placed-in-service date that qualifies for 100 percent bonus is one that falls after Sept. 27, 2017. However, taxpayers must be cognizant of the fact that the placed-in-service date is not the only date that determines eligibility for 100 percent bonus: the acquisition date is also relevant. Section 168(k)(8) contains a special rule phasing down the bonus percentage for assets acquired before Sept. 28, 2017. For such property, the applicable bonus percentage is as follows:
- Placed in service during 2017 – 50 percent
- Placed in service during 2018 – 40 percent
- Placed in service during 2019 – 30 percent
- Placed in service after 2019 – 0 percent [1]
Thus, in order to qualify for 100 percent bonus, both the acquisition date and the placed-in-service date of the qualified property must fall after September 27, 2017.
For luxury automobiles acquired before Sept. 28, 2017 and placed in service after Jan. 1, 2018, there is also a phase down of the section 280F limitation increase. For such vehicles, the section 280F limitation will be increased by the following amounts:
- Placed in service during 2018 – $6,400
- Placed in service during 2019 – $4,800
In determining the acquisition date, taxpayers should note two special rules under the existing Reg. section 1.168(k)-1 regulations. First, an asset will not be deemed to be acquired after a qualifying date if the taxpayer entered into a binding purchase contract for that asset prior to that qualifying date. Second, for self-constructed assets, the taxpayer is deemed to have “acquired” the asset once it begins its manufacture, construction, or production, which is further defined as when “physical work of a significant nature” begins. Under the available safe harbor, “physical work of a significant nature” begins when 10 percent of the property’s total cost is incurred. Taxpayers contracting for the manufacture, construction, or production of an asset are treated as self-constructing the asset. While the IRS has not updated Reg. section 1.168(k)-1 since tax reform passed, there is no reason to expect divergent guidance on either of these issues.
Qualified improvement property
The second item taxpayers should be aware of involves what appears to be a drafting error concerning the changes to qualified improvement property (QIP). Before the tax reform changes, there were multiple categories of real property improvements: some qualified for a shortened 15-year recovery life and some qualified for bonus depreciation. The rules for the various categories were disparate and often confusing. Based on the language contained in the Conference Committee’s Joint Explanatory Statement, Congress intended to make two key changes in this area:
1. Strike the various improvement categories, leaving only qualified improvement property, and
2. Make QIP 15 year property (and as such would be eligible for bonus depreciation).
Congress effected the first change without issue. The second, however, they did not. Under existing tax law, the scope of bonus-qualified property already included assets with a recovery period of 20 years or less. As such, changing QIP’s recovery period to 15 years would automatically qualify it for bonus, and the special rule previously qualifying QIP for bonus depreciation would become unnecessary. Therefore, presumably in anticipation of the change in recovery period, Congress transferred the definition of QIP out of the bonus depreciation subsection and removed its explicit-qualification for bonus depreciation. The problem is, however, that the drafters missed the final step: a provision allowing a 15-year recovery period for QIP was not part of the final bill. The result is that, it may require a technical correction for QIP placed in service in 2018 or later to have a recovery period of 15 years and be eligible for bonus. Because of the Jan. 1, 2018 effective date for these changes, QIP placed in service before that date qualifies for bonus under predecessor sec. 168(k). For the lucky few taxpayers who acquired QIP after Sept. 27, 2017 and placed it into service prior to Jan. 1, 2018, 100 percent bonus should apply. However, due to the nature of improvement property, taxpayers should pay particularly close attention to the acquisition date rules, discussed above, when determining whether their assets fall within that small window.
Takeaway
The new opportunity for 100 percent bonus depreciation, while beneficial to many taxpayers, is not available to all. The discussion above covers only two of the many issues taxpayers must analyze in order to accurately apply these new rules. As always, taxpayers should consult their tax advisers to determine the proper depreciation treatment for their business property.
[1] Dates vary slightly for long production period property and certain aircraft. See sec. 168(k)(8).
