Updated IRS Regulations for Bonus Depreciation under the Tax Cuts and Jobs Act

Treasury and IRS published regulations on September 13, 2019, providing guidance on the new bonus depreciation rules under the Tax Cuts and Jobs Act (TCJA). This action finalizes proposed regulations issued in August 2019 and provides a new set of additional proposed regulations. The new proposed regulations are intended to be effective for tax years containing the date on which the regulations are published as final, but provides that taxpayers can elect to rely on them prior to that date.

Bonus depreciation was increased by the TCJA from 50% to 100% of qualifying cost for assets acquired and placed in service after September 27, 2017. It also removed the “original use” requirement that existed under prior law, allowing bonus depreciation to now be taken on used property. However, to avoid the churning of assets, the law provides that used property does not qualify if it was previously owned by the same taxpayer or a predecessor at any time prior to its current ownership.

The August regulations provided that a taxpayer had prior use only where it held a “depreciable interest” in the asset. Use of property as a lessee under an operating lease generally would not create a depreciable interest and not be considered prior use under this rule.

The TCJA provides that certain assets do not qualify for bonus depreciation. This includes property which is otherwise eligible but is used in certain Excluded Businesses – i.e., trades or businesses described in IRC section 168(k)(9)(A) (i.e., utilities) or 168(k)(9)(B) (trade or business with floor plan financing indebtedness). The exclusion applies with respect to a business with floor plan financing indebtedness under the law if floor plan financing interest (FPFI) related to such debt “was taken into account” under the section 163(j) business interest limitation rule.

The new proposed regulations provide some beneficial rules with respect to property used in Excluded Businesses:

• A business that leases property to an Excluded Business will be eligible for bonus depreciation if the property is otherwise qualified. The property is not tainted by the use of the property by the Excluded Business lessee.
• A business with floor plan financing interest (e.g., automobile dealership) will be barred from taking bonus depreciation on its business assets only if the special rule under sec 163(j) (business interest expense limitation rule), permitting floor plan financing interest to be 100% deductible, is actually used. If there is sufficient business interest income and adjusted taxable income (items defined under the interest limitation rules) to permit the deduction of all business interest expense (including floor plan financing interest expense), then bonus depreciation is allowed.
• The regulations conclude that the special treatment of FPFI has not been taken into account. Since this may change from year-to-year, the IRS provides that this is an annual test. Consequently, restriction on bonus depreciation in one year does not necessarily block bonus depreciation in future years.
• Special rules are provided to determine whether a taxpayer or a predecessor is considered to have previously used the acquired property.
• Members who have left consolidated groups of corporations or who change consolidated groups are not considered as previously using property in which the former consolidated group had a depreciable interest (unless that particular member was the holder of such interest).
• A partner is considered as having a depreciable interest in property held by a partnership to the extent of the ratio of the share of depreciation deductions allocated to such partner over the total amount of such deductions for the current and prior five tax years.
• A de minimis rule is created which ignores, in certain situations, prior use by the taxpayer of 90 days or less.

The new regulations also create an election which applies to components acquired after September 27, 2017, which form part of self-constructed property where construction began prior to that date. The intention of this election is to permit the components to be eligible for 100% bonus depreciation.

The regulations do not address a fix for the Qualified Improvement Property glitch which exists in the TCJA. The intention of the new law was to establish a fifteen year cost recovery period for qualified improvement property, which would make these costs eligible for bonus depreciation. The law eliminates, as of December 31, 2017, the categories known as qualified leasehold improvement property, qualified restaurant property, and qualified retail property, and replaces them by qualified improvement property. Due to a drafting error, qualified improvement property was never provided for a fifteen year life under the statute. The Treasury asserts that it does not have the power to take corrective action under the regulations, despite requests from lawmakers and Congressional staff. Consequently, qualified improvement property is subject to a 39 year depreciation life and is not eligible for bonus.

The final regulations do confirm the position taken by Treasury under the August regulations that due the difference in the effective dates of the elimination of the categories of real property improvements and the increase in bonus depreciation, improvements which fall under the old categories for the interim period September 28, 2017 and December 31, 2017 qualify as fifteen year property and are eligible for bonus depreciation.

Since these regulations were issued so close to the extended due date for filing business entity income tax returns for 2018, it is possible that treatment of bonus depreciation should be reviewed in light of these and other rules found in the new regulations.

For questions on how the new guidance impacts your tax situation, please contact your Marcum tax professional for assistance.