The IRS has released long-anticipated final bonus depreciation rules, which will implement the first-year 100% deduction that was included in the Tax Cuts and Jobs Act (TCJA). Please note that these final regulations change a few aspects of the proposed regulations that were issued in August 2018.
The final regulations will enable companies to write off most of their depreciable business assets in the year they are first placed in service. The deduction typically applies to depreciable business assets with a recovery period of 20 years or less, as well as some other property.
Details are as follows:
Taxpayers can choose which regulations to apply for 2018-2020, but they will need to apply final regulations post-2020.
- Taxpayers can apply the final regulations for property acquired and placed in service after September 27, 2017 for a tax year ending on or after September 28, 2017.
- Alternatively, taxpayers can apply the proposed regulations for property acquired and placed in service after September 27, 2017 for a tax year ending on or after September 28, 2017, for tax years ending before the taxpayer's first taxable year that begins on or after January 1, 2021.
For “used” property that qualifies for bonus depreciation, the IRS clarifies the five-year safe harbor. (This rule was in the proposed regulations.)
- “Used” property includes property that the current or prior owner held a depreciable interest in for the prior five years (even if depreciation was not actually taken). In other words, you only have to look back five years to see if the prior owner or new owner had an interest in the property during the five years.
- The IRS just clarifies that you start the five-year period for the current owner and prior owner based on the date they placed the property in service. Also, if the taxpayer was not in existence for five years, you just look at the shorter period that they were in existence.
For “used” property that qualifies for bonus depreciation, the IRS clarifies the de minimis use rule.
(This rule was in the proposed regulations.)
- The final rule states that “used” property is not considered used if the taxpayer disposes of it to an unrelated party within 90 days of placing the property into service. But if the taxpayer reacquires the property after this period during the same tax year as the disposal, then this rule does not apply (i.e., no de minimis use rule).
- The IRS clarifies that you can reacquire property in year two or later and qualify for first year bonus depreciation again as you can apply the de minimis use rule each year.
The bonus depreciation rules include timing rules to ensure taxpayers get bonus depreciation for property “acquired” during the short timeframe intended by Congress (i.e., from the enactment of the TCJA and the ensuing bonus years). These are timing rules for property acquired around the time the TCJA was enacted and on the back end when the TCJA expires. The final regulations make it easier to apply the rules.
- For bonus depreciation, the property has to be “acquired” pursuant to a written and binding contract after September 27, 2017.
- For self-constructed property, the acquisition rules are deemed to be met if the taxpayer begins manufacturing, constructing or producing the property after September 27, 2017.
- The question is what to do about a component for a building when the building was acquired prior to September 27, 2017, but the component was acquired after.
- The proposed regulations allowed for a “component election” in this situation. It allows the component to be treated as bonus-eligible as it is not part of the larger property for this purpose. Don't confuse this with the UOP and component depreciation rules. They are not the same. This component election here is just to treat the components as part of the larger property for the timing rules. The component election is an exception to the “acquisition” rules for bonus.
- The proposed regulations describe it as follows:
1. If the manufacture, construction or production of the larger self-constructed property began before September 28, 2017, the larger self-constructed property and any self-constructed components related to the larger self-constructed property do not qualify for the additional first-year depreciation deduction under this section.
2. If the manufacture, construction or production of a component begins after September 27, 2017, but the manufacture, construction or production of the larger self-constructed property does not begin before January 1, 2027, the component qualifies for the additional first-year depreciation deduction under this section, assuming all other requirements are met, but the larger self-constructed property does not.
- The final regulations clarify this. They delete the dates and just look to placed-in-service dates, and state that if the property is MACRS property with a recovery period of 20 years or less, then you can apply the component election to that component. That makes it bonus-eligible, even if the larger property did not qualify. Also, the regulations clarify that the larger component is the UOP for the tangible property regulations, not the building, which lines up with the UOP rules for cost segregation. This just affirms that what ETS is already doing is fine. Taxpayers will have to include an election with their return for this.
The QIP fix that made it 15-year property added language saying that to be QIP, the improvement must be “made by the taxpayer.”
- The final regulations clarifify “made by the taxpayer.”
The final regulations state: “An improvement is made by the taxpayer if the taxpayer makes, manufactures, constructs or produces the improvement for itself or if the improvement is made, manufactured, constructed or produced for the taxpayer by another person under a written contract. In contrast, if a taxpayer acquires nonresidential real property in a taxable transaction and such nonresidential real property includes an improvement previously placed in service by the seller of such nonresidential real property, the improvement is not made by the taxpayer.”
- Therefore, it appears that there is no QIP treatment for the person who acquires used nonresidential real property. Maybe a cost segregation cannot go back and identify QIP for used nonresidential real property. This leaves a lot of questions answered, such as if the property did not qualify as QIP under the old QIP rules….
The IRS and the Treasury Department plan to issue procedural guidance for taxpayers to opt to apply these final regulations for prior taxable years, or to rely on the proposed regulations issued September 2019.
Engineered Tax Services is available to answer any of your questions regarding these final depreciation regulations. Our engineering and tax professionals help real estate owners and investors significantly increase their cash flow by identifying and reclassifying assets of their building for faster depreciation. Our goal is to ensure you’re on track and utilizing this strategic tax tool for real estate. Request a free benefit analysis to identify an estimated benefit and ensure a cost segregation study makes sense for your property.