cost

TECHNICAL
UPDATE


TCJA – BONUS DEPRECIATION CONSIDERATIONS

February 14, 2018 by Charles Duncan

Understanding bonus depreciation is not so simple:

Most taxpayers and tax practitioners view bonus depreciation in a straightforward manner: If an asset is placed-in-service between certain dates, it is eligible for that period’s bonus depreciation. With the passage of the Tax Cuts and Jobs Act, Public Law No. 115-97 (TCJA), and the expansion of property eligible for bonus depreciation at a higher rate of 100%, practitioners should revisit the basic eligibility requirements for bonus depreciation. Today, we will look at the most basic requirements: (1) the placed-inservice requirement; and, (2) the acquisition requirement. We will finish with a discussion of what qualifies and doesn’t qualify for bonus depreciation going forward under the TCJA.

(1) Placed-in-Service Rules

Most taxpayers and tax practitioners accept the placed-in-service dates in the taxpayer’s books and records without question. This is with good reason. Historically, as long as an asset was placed-in-service ear the proper date, any adjustment would at most be a small timing difference. The introduction of bonus depreciation in 2001 turned this old logic on its head, but only made the timing difference larger. With the introduction of Qualified Improvement Property1 (“QIP”), which made bonus depreciation available for new interior improvements to existing non-residential real estate, and the more recent Tax Cuts and Jobs Act of 2017, the stakes for correctly determining the placed-in-service date were raised once again. Fortunately, recent case law developments have emphasized the importance of determining placed-inservice dates properly. Since the placed-in-service date is a primary factor in determining whether and
how much bonus depreciation an asset receives, determining the correct placed-in-service date and, if
necessary, fixing incorrect placed-in-service dates is now an important component of any cost segregation
study. The following bullet points summarize the placed-in-service rules.

  • General rule: Property is first placed-in-service when first placed in a condition or state of readiness and availability for a specifically assigned function, whether in a trade or business, in the production of income, in tax-exempt activity, or in a personal activity. 2
    • The trade or business must have commenced before depreciation can begin. 3
    • Machinery and equipment is generally placed-in-service no earlier than when installed in a functioning location.4 But assets may be placed-in-service if events outside the taxpayer’s control prevent their use.5
    • Under the regulations, buildings are considered placed in service when they are substantially complete and are in a condition or state of readiness and availability.6 In the recent Stine case, the taxpayer was allowed to claim bonus depreciation on buildings even though the location had not yet opened for business.7 In Action on Decision 2017-02, the IRS announced they would continue to litigate this issue and considers buildings placed in service when ready and available for its regular operation and income-producing use.
  • Fixing incorrect placed-in-service dates: To fix an incorrect placed-in-service date, the taxpayer may make an adjustment in the earliest open year or in the current (and subsequent) years.8 This fix is not considered an accounting method change,9 so filing a Form 3115, Application for Change in Accounting Method is not necessary. When correcting placed-in-service dates at the same time as a lookback cost segregation study, the taxpayer will need to determine whether to fix the placed-in-service dates on an amended return before the cost segregation study is implemented or in the current year following the cost segregation study. In both cases, the depreciation adjustments will be separate from the section 481(a) adjustment appearing on the Form 3115.

(2) Acquisition Rules

The other basic requirement for bonus depreciation is the acquisition requirement. This rule differs depending on whether the asset was acquired (via purchase) or self-constructed. The following bullet points summarize the acquisition rules.

  • Acquired property: A legally binding contract10must be entered into during the specified dates when bonus depreciation is effective and must meet two requirements:

     

    • The contract is legally binding against the taxpayer under state law.
    • The contract does not limit damages to a specified amount, (unless the damages arenlimited to at least 5% of the contract price).
    • Note: Though its effect is unclear, the flush language of section 13201(h) of the Tax Cuts and Jobs Act may eliminate the damage limitation rule.
  • Self-constructed property: The taxpayer must begin manufacturing, constructing, or producing during the specified dates when bonus depreciation is effective.11 Self-constructed property includes property produced under a contract by another, e.g. a general contractor.

     

    • Manufacturing, construction, or production begins when physical work of a significant nature begins. Physical work does not include preliminary activities such as planning or designing, securing financing, exploring, or researching.
    • The 10% Safe Harbor – Physical work of a significant nature does not begin until the taxpayer has paid or incurred more than 10% of the total cost of the property (not including land or preliminary activities).

Relevance of Placed-in-Service and Acquisition to TCJA Bonus Depreciation

The placed-in-service and acquisition rules have been a feature of bonus depreciation since it was first enacted after 9/11. These rules have been largely overlooked due to the many consecutive years of 50% bonus depreciation. Since the TCJA increases bonus depreciation to 100% and the eliminates the original use requirement,12 we must look at the TCJA’s effective date for bonus depreciation, 9.27.2017, to determine whether property is governed by the TCJA or the PATH Act. If property does not meet the tests for bonus depreciation under the TCJA, we must necessarily fall back on the prior PATH Act to determine what, if any, bonus deprecation applies. This leads to scenarios where some assets placed-in-service after 9.27.2017 may qualify for 100%, 50%, 40%, or no bonus depreciation depending on the specific facts and circumstances.

Assets qualifying for 100% bonus must meet both placed-in-service and acquisition rules. The following table attempts to address the majority of scenarios that are likely to come up during the transition from the PATH Act to the TCJA rules..

The Impact of the TCJA on Bonus Depreciation


  • 100% Bonus depreciation: The TCJA increases bonus depreciation from 50%, under the PATH Act, to 100% for property acquired and placed in service after 9.27.2017 and before 1.01.2023. Bonus drops to 80% in 2023 and continues to drop 20% every year until it is eliminated in 2027.18 100% bonus is contingent on the placed-in-service and acquisition rules discussed previously.
  • Original use: The original use requirement, which has been integral to bonus depreciation since 2001, is eliminated after 9.27.2017. Bonus now applies to purchases of used as well as new items.19
  • Limitations: There are certain limitations spelled out in the TCJA:
    • In the case of trade-ins, like-kind exchanges, or involuntary conversions, bonus depreciation applies only to any money paid in addition to the traded-in property or in excess of the adjusted basis of the replaced property.
    • It does not apply to:
      • property acquired in a nontaxable exchange such as a reorganization, property acquired from a member of the taxpayer’s family (including a spouse, ancestors, and lineal descendants), another related entity as defined in section 267, nor to property acquired from a person who controls, is controlled by, or is under common control with, the taxpayer; nor to
      • property used in certain utility trade or businesses.
    • To prevent abuses, the additional first-year depreciation deduction applies only to property acquired from an unrelated party. It does not apply to property received as a gift or from a decedent.20
  • Qualified Improvement Property (QIP) bonus: QIP no longer receives bonus depreciation after 12.31.2017.21
  • Bonus depreciation by year: The following table illustrates what type of bonus depreciation is available in which years.
    • After 12.31.17, bonus depreciation arising from a cost segregation study generally applies to section 1245 property and 15 year section 1250 land improvement property (LIP).
    • The period from 9.28.17 – 12.31.17 is interesting because it marks the overlap of the older PATH Act rules with the new TCJA rules. It also potentially offers the greatest opportunities for a taxpayer who capitalizes assets that meet the criteria discussed earlier for placedin-service and acquisition:

       

      • The tax rates are still the 2017 tax rates;
      • 15 year Qualified Retail Improvement Property, Qualified Restaurant Property, and
        Qualified Leasehold Improvement Property still exist22;
      • bonus still applies to QIP until 12.31.17;
      • bonus is 100% beginning after 9.27.17; and
        the original use limitation for bonus depreciation is eliminated.

  1. PATH Act, P.L. 114-113, 12/18/2015.
  2. Treas. Reg. § 1.167(a)-11(c)(vii)(e).
  3. Simonson v. United States, 752 F.2d 341 (8th Cir. 1985).
  4. Piggly Wiggly v. Comm’r, 84 T.C.739 (1985).
  5. Sears Oil Co., Inc. v. Comm’r, 359 F.2d 191 (2nd Cir. 1966).
  6. Treas. Reg. § 1.167(a)-11(c)(vii)(e).
  7. Stine, LLC v. United States, 2015 U.S. Dist. LEXIS 9850, 2015-1 U.S. Tax Cas. (CCH) ¶50,172, 115 A.F.T.R.2d (RIA) 637, 2015 WL 403146 (W.D.La. 2015).
  8. Treas. Reg. § 1.446-1(e)(2)(ii)(d)(5)(v).
  9. Treas. Reg. §1.446-1(e)(2)(ii)(d)(3)(v).
  10. Treas. Reg. § 1.168(k)-1(b)(4)(ii).
  11. Treas. Reg. § 1.168(k)-1(b)(4)(iii).
  12. I.R.C. § 168(k)(2)(E)(ii) as amended by the 2017 Tax Cuts and Jobs Act § 13201(c)(2). Note that this table is not designed to apply to longer production period property such as aircraft. For property with a longer production period, refer to I.R.C. § 168(k)(6)(B) as amended by the 2017 Tax Cuts and Jobs Act § 13201(a)(2).
  13. Protecting Americans from Tax hikes Act of 2015.
  14. I.R.C. § 168(k)(2)(E)(ii) as amended by the 2017 Tax Cuts and Jobs Act § 13201(c)(2).
  15. Tax Cuts and Jobs Act of 2017.
  16. I.R.C. § 168(k)(6) as amended by the 2017 Tax Cuts and Jobs Act § 13201(a)(2).
  17. I.R.C. § 168(k)(6) as amended by the 2017 Tax Cuts and Jobs Act § 13201(a)(2).
  18. I.R.C. § 168(k)(2)(E)(ii) as amended by the 2017 Tax Cuts and Jobs Act § 13201(c)(2).
  19. § 13204(a)(4)(A) of the TCJA removed QIP from the list of property eligible for bonus depreciation. This may have been a drafting error but remains in effect until such time as a technical correction is issued.
  20. QIP replaces QLHI, QRIP, and QRP for property placed in service after 12.31.17 but DOES NOT have a 15-year recovery period. This is a drafting error, but requires a legislative fix.
  21. For property with a longer production period, refer to I.R.C. § 168(k)(6)(B) as amended by the 2017 Tax Cuts and Jobs Act § 13201(a)(2).
  22. 15 year land improvements (LIP), whether § 1245 or § 1250 property, mirror treatment of § 1245 property.
  23. QRP & QRIP have never received bonus unless also QLHI. From 2016 – 2017 this changes. They receive bonus depreciation if also QIP. All QRIP & QLHI will be QIP & some, but not all, QRP will be QIP.
  24. QIP was introduced by the PATH Act. It applies to most new 15 and 39 year interior improvements.