Bonus depreciation, equivalent to full expensing of qualified assets, was made available as part of the Tax Cuts and Jobs Act enacted in Dec. of 2017. On Sept. 13, 2019, Treasury and the IRS released proposed regulations interpreting the section 168(k) bonus depreciation rules (the Proposed Regulations). The proposed regulations address in detail how certain bonus depreciation eligibility requirements apply to certain transactions involving affiliated corporations that file consolidated federal income tax returns (Consolidated Groups).
The Proposed Regulations were released simultaneously with final regulations under section 168(k), which we cover in separate Alerts available here and here. This Alert focuses solely on the Consolidated Group-specific aspects of the Proposed Regulations. Previously proposed regulations under section 168(k) issued in Aug. 2018 (the Prior Proposed Regulations, see our prior Alert) addressed certain Consolidated Group issues. The Proposed Regulations’ Consolidated Group provisions improve upon those in the Prior Proposed Regulations.
The no prior use requirement in general
Section 168(k), as amended by the TCJA, allows a 100% additional first year depreciation deduction for qualified property acquired and placed in service after Sept. 27, 2017, and placed in service before Jan. 1, 2023. In addition to increasing the bonus depreciation percentage to 100%, the TCJA removed the prior law limitation of bonus depreciation to new property only. Although a taxpayer may now claim bonus depreciation for previously used property it acquires and uses in its trade or business, bonus depreciation is not available if taxpayer (or a predecessor of the taxpayer) previously used the property (the No Prior Use Requirement).
The no prior use requirement –Consolidated Group-specific rules
The Proposed Regulations, like the Prior Proposed Regulations, address application of the No Prior Use Rule to Consolidated Groups. The Proposed Regulations generally provide clarifications of and improvements to the Consolidated Group rules under the Prior Proposed Regulations.
The Prior Proposed Regulations generally applied the No Prior Use Requirement to a Consolidated Group as if it were a single taxpayer. The Prior Proposed Regulations further provided that the No Prior Use Requirement would not be met if, as part of a series of related transactions, property is acquired by a member of a consolidated group and a corporation that had a depreciable interest in the property becomes a member of that consolidated group (the Group Prior Use Rule). The Prior Regulations also provided that if the acquisition of property is part of a series of related transactions that also include one or more transactions in which the transferee of the property ceases to be a member of a Consolidated Group, then whether the taxpayer is a member of a Consolidated Group is tested immediately after the last transaction in the series.
However, the Prior Proposed Regulations left open the application of the Group Prior Use Rule in situations in which a Consolidated Group terminates, including termination as a result of a reverse acquisition under Regulation section 1.1502-75(d)(3). The Proposed Regulations clarify that the Group Prior Use Rule as laid out in the Prior Regulations should only apply as long as the Consolidated Group remains in existence.
Further, the Proposed Regulations specify that the Group Prior Use Rule only applies as long as a corporation remains a member of a Consolidated Group. Under this rule, when a Consolidated Group member deconsolidates, it does not continue to be treated under the Group Prior Use Rule as having used the Consolidated Group’s property unless it actually owned such property.
The Proposed Regulations also create two new rules that apply to acquisitions of property in the context of Consolidated Groups: (1) the Proposed Consolidated Acquisition Rule, and (2) the Proposed Consolidated Deemed Acquisition Rule. The former applies where (i) one member of a Consolidated Group acquires depreciable property from another member of the group in a taxable transaction, and (ii) the corporation acquiring the property (the transferee member) ceases to be a member of the selling Consolidated Group within 90 days of the property acquisition in a series of related transactions that includes the property acquisition. In that fact pattern, the Proposed Consolidated Acquisition Rule applies to treat the disposition and acquisition as occurring one day after the date on which the transferee member ceases to be a member (the deconsolidation date), and the transferee member is treated as placing the property into service not earlier than one day after the deconsolidation date.
To exemplify this Proposed Consolidated Acquisition Rule, the Proposed Regulations point to Example 21 in the Prior Proposed Regulations. In that example, P is the common parent of a Consolidated Group that includes F and G as members. G has a depreciable interest in equipment. As part of a series of related transactions, (i) G sells the equipment to F, and then (ii) P sells its F stock to X, an unrelated parent of a different Consolidated Group. The Prior Regulations provide that the Group Prior Use Rule does not apply to treat F as previously having a depreciable interest in the equipment because F’s status is tested after the last transaction in the series of related transactions. As a result, under the Prior Proposed Regulations, F would be eligible to claim the additional first year depreciation deduction. Questions arose under the Prior Proposed Regulations, however, as to whether the equipment would be treated as having been placed in service in the P group. The Proposed Regulations now clarify that the deduction should instead be reported on the acquiring group’s (X’s) return. The No Prior Use Requirement is satisfied, as the rule treats the transferee group member (F) as acquiring the property after departing the P group.
The Proposed Consolidated Deemed Acquisition Rule applies in a similar manner in the case of a deemed asset acquisition under sections 338(h)(10) or 336(e) after which the acquirer is treated for federal income tax purposes as a new corporation. The rule applies if (i) the transferee member of a Consolidated Group acquires the stock of another member of the same group (the target) that holds depreciable property in a qualified stock purchase or disposition for which a section 338 or 336(e) election is made, and (ii) the transferee member and target cease to be members of the Consolidated Group within 90 calendar days of the acquisition or disposition date. Similar to the Proposed Consolidated Acquisition Rule, the transferee member (or new target, as the case may be) is treated as placing the property in service no earlier than one day after the deconsolidation.
The Proposed Regulations, in particular the provisions above related to the treatment of Consolidated Groups, are proposed to apply to qualified property placed in service after the taxpayer’s taxable year that includes the date of publication of the Proposed Regulations as final. Pending finalization, taxpayers may choose to rely on the Proposed Regulations, but must consistently apply all rules of the Proposed Regulations.
The Proposed Regulations add some much needed clarity to the application of certain of the related party acquisition rules in the case of Consolidated Groups. Taxpayers should consult with their tax advisors regarding the availability of bonus depreciation if they are undergoing transactions resulting in a stepped-up asset tax basis.