As taxpayers diligently work to finalize their tax returns, the Treasury and IRS released final (T.D. 9874) and proposed (REG-106808-19) regulations related to bonus depreciation under section 168(k). The final regulations contain several notable changes, but they generally follow the proposed regulations (REG-104397-19) issued in Aug. of 2018. For example, the final regulations continue to indicate that a legislative change must occur to change the recovery period of qualified improvement property. The new proposed regulations may provide additional opportunities for taxpayer to apply 100% bonus depreciation.
The final regulations apply to property acquired and placed into service after Sept. 27, 2017. For property to qualify for 100% bonus depreciations, property must meet the definition of qualified property, be the original use or acquired used property, satisfy the placed-in-service date requirement, and meet the requirement for the 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:
o Qualified leasehold improvement property;
o Qualified improvement property under the pre-TCJA definition;
o Qualified restaurant property; and
o Qualified retail improvement property.
• Certain computer software;
• Water utility property;
• Qualified film or television production;
• Qualified live theatrical production; and
• Certain specified plants.
Qualified property must have the original use commence with a taxpayer, or a taxpayer has to have an eligible acquisition of qualified used property. The final regulations retain the original use standard that existed under prior law, including the 20% rule for reconditioned or rebuilt property. The final regulations also retain the same rules for fractional ownership property.
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. The final regulations provide a new definition of predecessor and a lookback period of five calendar years to determine if a taxpayer or a predecessor had a depreciable interest prior to an acquisition. As discussed below, the new proposed regulations address many of the anti‑abuse provisions for members of a consolidated group, certain series of related transactions, and related party transactions. The rules require considerable attention when structuring transactions to understand if a taxpayer has ever had a prior depreciable interest in the property.
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 final regulations is the definition of a written binding contract. Remember, to qualify for 100% bonus depreciation, a taxpayer must acquire property after Sept. 27, 2017, or acquire the property pursuant to a written binding contract entered into after Sept. 27, 2017. In recognition of the fact that not all contracts are binding on the contract date, the final regulations provide that the acquisition date is the later of (1) the date on which the contract was entered into; (2) the date the contract becomes enforceable under State law; (3) if the contract has one or more cancellation periods, the date all cancellation periods end; or (4) the date all conditions subject to any contingency clauses are satisfied.
The final 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 5% or more of the total contract price, the final regulations will not treat it as limiting damages to a specified amount. A taxpayer must consider only the provision with the highest damages if a contract has multiple provisions that limit damages. Making insubstantial changes to a contract will not change the date of acquisition under the written binding contract. The final regulations indicate that an option and a letter of intent are not binding contacts. In addition, the final regulations will not treat supply agreements as written binding contracts until a taxpayer provides amount and design specifications under the contract.
In sharp contrast to the 2018 proposed regulations, the final regulations reinstate the safe harbor for property produced under a contract. Taxpayers may treat property produced under a contract as if a taxpayer directly produced the item and the rules include a safe harbor. Under the safe harbor, until the customer incurs 10% of the costs, the rules do not consider a taxpayer to have begun production.
The final regulations apply to property placed in service by the taxpayer during or after its taxable year that includes the date of publication in the federal register. A taxpayer may choose to apply the final regulations, in their entirety, to qualified property acquired and placed in service after Sept. 27, 2017, by the taxpayer during the taxable year ending on or after Sept. 28, 2017. A taxpayer may rely on the proposed regulations issued in Aug. of 2018 for qualified property acquired and placed in service after Sept. 27, 2017, by the taxpayer during taxable years ending on or after Sept. 28, 2017 and ending before the date of publication in the federal register.
The proposed regulations offer guidance for issues not addressed by the final regulations. The Preamble notes that many of the new rules may cause more property to qualify for bonus depreciation, increasing the incentive for taxpayers to invest. Specifically, the guidance provides for the following:
• If a taxpayer does not receive a benefit under section 163(j) related to floor plan financing interest in a taxable year, then the taxpayer may use bonus depreciation for qualified property.
• An annual determination for whether a trade or business has had floor plan financing indebtedness taken into account.
• 100% bonus for a lessor that leases property to certain public utilities or trades or businesses with floor plan financing if the lessor is not in such trades or businesses.
• Guidance on whether property is primarily used in a trade or business described in section 168(k)(9)(A) (relating to certain public utilities).
• An exception to the depreciable interest rule when a taxpayer disposed of property within a short period after the taxpayer places such property in service.
• Clarification regarding a partner’s depreciable interest in property held by the partnership. Revisions to the rules for a series of related transactions.
• New special rules for a consolidated group. A new binding contract rule for the acquisition of a trade or business or an entity.
• 10% safe harbor for property not acquired pursuant to a written binding contract.
• An election to treat one or more components of larger self-constructed property as eligible for 100% bonus.
A taxpayer may choose to rely on the proposed regulations, in their entirety, for qualified property acquired and placed in service after Sept. 27, 2017, by the taxpayer during taxable years ending on or after Sept. 28, 2017. A taxpayer also may choose to rely on the proposed regulations, in their entirety, for components, acquired or self-constructed after Sept. 27, 2017, of larger self-constructed property for which production begins before Sept. 28, 2017, and that is qualified property under section 168(k)(2) as in effect before the enactment of TCJA and placed in service by the taxpayer during taxable years ending on or after Sept. 28, 2017. If a taxpayer chooses to rely on the proposed regulations, the taxpayer must consistently apply all rules of the proposed regulations.
Although many taxpayers have filed their returns or do not have enough time to apply the new rules to their returns before their filing due date, taxpayers may want to apply the final regulations or rely upon the proposed regulations. Taxpayers may have an opportunity to file a superseding return, amend a 2017 tax return, or file an accounting method change to follow the final or proposed regulations with a historical adjustment. Also, taxpayers will need to give additional consideration to M&A or restructuring transactions to determine whether bonus depreciation applies. Taxpayers are encouraged to contact a tax professional to determine the potential impact of the proposed regulations.