Final regulations regarding bonus depreciation address basis step-ups
TAX ALERT |
Bonus depreciation, which is tantamount to full expensing, is available only for certain tangible assets, and not for intangible assets like goodwill. Before the 2017 tax law changes, ‘used’ assets were not eligible for bonus depreciation – bonus depreciation was only available for an asset’s ‘original use’. Therefore, bonus depreciation had limited applicability, if any, to an acquisition of an existing business.
The 2017 tax law changed this rule to allow bonus depreciation for purchases of previously used assets. Consequently, certain acquisition transactions, including purchases of interests in certain businesses, can result in bonus depreciation eligibility. The IRS outlined the application of bonus depreciation to many common acquisition structures in proposed regulations issued on Aug. 8, 2018. For a more detailed discussion of those proposed regulations, see our earlier Alert.
The IRS has now issued final regulations and new proposed regulations on bonus depreciation. The final regulations closely resemble the original proposed regulations in their treatment of common acquisition transactions, whereas the new proposed regulations add clarity for certain items that were not previously addressed.
The final regulations confirm the application of bonus depreciation rules to common ‘stepped-up’ basis transactions described below. Bonus depreciation is generally available for basis adjustments related to:
- Purchases of an interest in an ongoing partnership (or entity taxed as a partnership). The portion of the Section 743 adjustment related to otherwise qualified assets may create eligible deductions for the purchasing partner. Bonus depreciation eligibility under this rule may apply to a purchasing partner that was already a partner in the partnership prior to the purchase. Bonus depreciation can be elected separately for the Section 743 adjustment, regardless of whether the partnership itself elects bonus depreciation for the same assets.
- Purchases of all of the interests in an existing partnership by a single new party who is not currently a partner. The deemed asset purchase treatment under Revenue Ruling 99-6 may create eligible deductions for the purchaser.
- Purchases of a portion of the interests in an entity that was previously disregarded, but becomes a partnership for tax purposes. The deemed asset purchase treatment under Revenue Ruling 99-5 may create eligible deductions for the purchaser, but not the partnership itself. The final regulations clarify that this deduction is taken by the purchaser directly, not specially allocated to the purchasing partner by the partnership.
- Corporate stock purchases and dispositions made with elections. Section 338 elections and section 336(e) elections result in treatment of an acquisition as an asset acquisition for federal income tax purposes. Bonus depreciation generally is available for the stepped-up tax basis of property acquired in these transactions, because the deemed asset acquirer is treated as a new corporation for federal income tax purposes following the transaction. The final regulations add an exception, however, for situations involving a section 336(e) election and a spin-off transaction subject to section 355(d)(2) or section 355(e)(2). Those situations involve certain spin-offs that are taxable at the corporate level (but not the shareholder level). The deemed asset acquirer in those situations is not treated as a new corporation for tax purposes.
Bonus depreciation will not apply to basis adjustments or special allocations arising from:
- Distributions of cash or property from a partnership Adjustments under Section 734 or Section 732 will not create eligible deductions for the partnership or for the partner receiving the property.
- Property contributions to corporations where gains are recognized due to the receipt of ‘boot’ A Section 351 corporate contribution transactions with boot (i.e., nonstock consideration transferred by the corporation) can result in tax basis step-ups. Those basis step-ups, however, are not eligible for bonus depreciation.
- Transactions between related parties as defined in Sections 267 or 707, or entities treated as a continuation of the seller. Purchases of property by a related party will not generate eligible deductions.
- Remedial allocations under Section 704(c) Computations of depreciation under the remedial method of section 704(c) are not to be computed using bonus depreciation. This includes instances when there is a revaluation of partnership property (often referred to as reverse Section 704(c) allocations).
The availability of bonus depreciation is somewhat uncertain, and not specifically addressed in regulations, for basis adjustments arising from:
- Purchases of all interests in an existing partnership by an existing partner. The application of the deemed distribution and deemed asset purchase treatment under Revenue Ruling 99-6 is unclear.
- The contribution of assets to a partnership in exchange for both equity and money. The availability of bonus depreciation on the portion of assets deemed sold to the partnership is unclear.
The original proposed regulations, along with the final regulations, provide guidance governing situations where an existing partner increases their proportionate ownership in partnership property. These rules generally allow for bonus depreciation to the extent that the purchasing partner did not previously own a depreciable interest in the underlying property. The new proposed regulations provide a method for calculating a partner’s prior depreciable interest in partnership property, which generally looks to the partner’s allocable share of depreciation over the prior five years.
The new proposed regulations also discuss bonus depreciation availability after certain transactions involving one or more corporations that file consolidated federal income tax returns. Those proposed regulations particularly focus on acquisitions of used property, and will be discussed in a separate Alert.
Taxpayers considering transactions that will trigger tax basis step-ups, or that have completed transactions resulting in basis step-ups, should analyze the transactions in order to determine whether and to what extent the basis step-ups are eligible for bonus depreciation.