New Bonus Depreciation Proposed Regs Issued

(Parker Tax Publishing October 2019)

The IRS issued, concurrently with final bonus depreciation regulations in T.D. 9874, proposed bonus depreciation regulations, which provide guidance not addressed in the final regulations and on which taxpayers may currently rely. The proposed regulations include rules relevant to the definition of qualified property, add special rules for consolidated groups, add new rules regarding components acquired or self-constructed after September 27, 2017, for larger self-constructed property for which manufacture, construction, or production began before September 28, 2017, and provide rules regarding the application of the mid-quarter convention as determined under Code Sec. 168(d). REG-106808-19.

Background

Code Sec. 168(k) allows a bonus depreciation deduction (i.e., bonus depreciation) in the placed-in-service year of qualified property. Subsequent amendments to Code Sec. 168(k) increased the percentage of the bonus depreciation deduction from 30 percent to 50 percent (to 100 percent for property acquired and placed in service after September 8, 2010, and generally before January 1, 2012), extended the placed-in-service date generally through December 31, 2019. On December 22, 2017, Code Sec. 168(k) and related provisions were amended by the Tax Cuts and Jobs Act of 2017 (TCJA) to provide further changes to the bonus depreciation deduction. The IRS published proposed regulations interpreting Code Sec. 168(k) in August of 2018 (2018 proposed regulations).

On September 13, the IRS issued final regulations in T.D. 9874 that adopted, with modifications, the 2018 proposed regulations as final regulations. Concurrently, the IRS issued new bonus depreciation proposed regulations (2019 proposed regulations) in which it withdrew the following regulations from the August 8 proposed regulations: Reg. Sec. 1.168(k)-2(b)(3)(iii)(B)(3)(i) through (iii) and Examples 19 through 22 in Reg. Sec. 1.168(k)-2(b)(3)(vi). In their place, the IRS issued Prop. Reg. Sec. 1.168(k)-2(b)(3)(v)(A) through (E) and Examples 26 through 30 in Prop. Reg. Sec. 1.168(k)-2(b)(3)(vii)(Z) through (DD), respectively. The new proposed regulations also withdrew the following from the August 8 proposed regulations: Reg. Sec. 1.168(k)-2(b)(3)(iii)(C) and Example 18 in Prop. Reg. Sec. 1.168(k)-2(b)(3)(vi), and proposed in their place Prop. Reg. Sec. 1.168(k)-2(b)(3)(iii)(C) and Examples 31 through 34 in Prop. Reg. Sec. 1.168(k)-2(b)(3)(vii)(EE) through (HH), respectively.

Proposed Regulations

The 2019 proposed regulations:

(1) provide rules relevant to the definition of "qualified property" for purposes of the bonus depreciation rules;

(2) add special rules for consolidated groups;

(3) add rules relating to components acquired or self-constructed after September 27, 2017, for larger self-constructed property for which the manufacture, construction, or production began before September 28, 2017; and

(4) add rules on the application of the mid-quarter convention, as determined under Code Sec. 168(d).

Property Excluded from Bonus Depreciation by Code Sec. 168(k)(9)

Under Reg. Sec.1.168(k)-2(b)(2)(ii)(F) of the final regulations, for property placed in service after December 31, 2017, qualified property does not include any property that is primarily used in a trade or business described in Code Sec. 163(j)(7)(A)(iv) (i.e., regulated utility trades or businesses). In addition, under Reg. Sec. 1.168(k)-2(b)(2)(ii)(G) of the final regulations, qualified property does not include any property used in a trade or business that has had floor plan financing indebtedness, as defined in Code Sec. 163(j)(9), if the floor plan financing interest related to such indebtedness is taken into account under Code Sec. 163(j)(1)(C) for the tax year. The 2019 proposed regulations provide that these exclusions do not apply to lessors of property to a trade or business described in Code Sec. 168(k)(9) (certain property used primarily in a trade or business of the furnishing or sale of (1) electrical energy, water, or sewage disposal services, (2) gas or steam through a local distribution system, or (3) transportation of gas or steam by pipeline) so long as the lessor is not described in Code Sec. 168(k)(9)(A) or (B).

Practitioners questioned how to determine whether property is primarily used in a trade or business described in Code Sec. 168(k)(9)(A). The IRS noted that, for depreciation purposes, property is classified according to its primary use and concluded that the same standard should apply for purposes of Code Sec. 168(k)(9)(A). Accordingly, the 2019 proposed regulations provide that for purposes of Code Sec. 168(k)(9)(A) and Reg. Sec.1.168(k)-2(b)(2)(ii)(F), the term primarily used has the same meaning as that term is used in Reg. Sec. 1.167(a)-11(b)(4)(iii)(b) and Reg. Sec. 1.167(a)-11(e)(3)(iii) for classifying property. Guidance was also requested on when floor plan financing is taken into account for purposes of Code Sec. 168(k)(9)(B). Under the proposed regulations, solely for purposes of Code Sec. 168(k)(9)(B) and Reg. Sec.1.168(k)-2(b)(2)(ii)(G), floor plan financing interest is not taken into account for the tax year by a trade or business that has had floor plan financing indebtedness if the sum of the amounts calculated under Code Sec. 163(j)(1)(A) and (B) for the trade or business for the tax year equals or exceeds the business interest, as defined in Code Sec. 163(j)(5), for the tax year.

If floor plan financing interest is taken into account for a tax year by a trade or business that has had floor plan financing indebtedness, practitioners questioned whether bonus depreciation is allowed for property placed in service by that trade or business in any subsequent tax year. According to the IRS, in such a case, bonus depreciation for subsequent tax years would not be allowed, even if the amount of the floor plan financing interest taken into account for the current tax year is de minimis. For this reason, for purposes of Code Sec. 168(k)(9)(B), the determination of whether a trade or business that has had floor plan financing indebtedness has taken into account floor plan financing interest is made annually. Accordingly, the 2019 proposed regulations provide that if the trade or business has taken floor plan financing interest into account for a tax year, Reg. Sec. 1.168(k)-2(b)(2)(ii)(G) applies to any property placed in service by that trade or business in that tax year.

Used Property

With respect to sale-leaseback transactions, the 2019 proposed regulations provide that if (1) a taxpayer acquires and places in service property, (2) the taxpayer or a predecessor did not previously have a depreciable interest in the property, (3) the taxpayer disposes of the property to an unrelated party within 90 calendar days after the date the property was originally placed in service by the taxpayer (without taking into account the applicable convention), and (4) the taxpayer reacquires and again places in service the property, the taxpayer's depreciable interest in the property during that 90-day period is not taken into account for determining whether the property was used by the taxpayer or a predecessor at any time before its reacquisition by the taxpayer. To prevent the churning of assets, this proposed rule does not apply if the taxpayer reacquires and again places in service the property during the same tax year the taxpayer disposed of the property. The 2019 proposed regulations define an unrelated party as meaning a person not described in Code Sec. 179(d)(2)(A) or (B), and Reg. Sec. 1.179-4(c)(1)(ii) or (iii), or (c)(2).

The 2019 proposed regulations address the treatment of a partner's depreciable interest in property held by a partnership. A partner is considered to have a depreciable interest in a portion of property equal to the partner's total share of depreciation deductions with respect to the property as a percentage of the total depreciation deductions allocated to all partners with respect to that property during the current calendar year and five calendar years immediately prior to the partnership's current placed-in-service year of the property. For this purpose, only the portion of the current calendar year and previous five-year period during which the partnership owned the property and the person was a partner is taken into account.

Under the 2018 proposed regulations, in the case of a series of related transactions, property is treated as directly transferred from the original transferor to the ultimate transferee, and the relationship between the original transferor and the ultimate transferee is tested immediately after the last transaction in the series (related transactions rule). The IRS was asked to clarify whether the related-transactions rule applies only to test relatedness under Code Sec. 179(d)(2)(A) or whether this rule applies more broadly for purposes of all of the rules under Code Sec. 168(k)(2)(E)(ii). The IRS was also asked to clarify whether the related-transactions rule applies to transactions in which qualified property is transferred in a transaction described in Code Sec. 168(i)(7) in the same tax year that the qualified property is placed in service by the transferor.

In response, the 2019 proposed regulations provide a proposed related-transactions rule, which generally provides that the relationship between the parties under Code Sec. 179(d)(2)(A) or (B) in a series of related transactions is tested immediately after each step in the series, and between the original transferor and the ultimate transferee immediately after the last transaction in the series. A party in the series that is neither the original transferor nor the ultimate transferee is disregarded in applying the relatedness test if the party placed in service and disposed of the property in the party's same tax year or did not place the property in service. Further, any step in a series of related transactions that is neither the original step nor the ultimate step is disregarded for purposes of testing relatedness if the step is a transfer of property in a transaction described in Code Sec. 168(i)(7) in the same tax year that the property is placed in service by the transferor. The proposed related-transactions rule does not apply when all transactions in the series are described in Reg. Sec. 1.168(k)-2(g)(1)(iii) or to a syndication transaction described in Reg. Sec. 1.168(k)-2(b)(3)(vi).

The 2019 proposed regulations include new rules covering the application of Code Sec. 179(d)(2)(B) to acquisitions of depreciable property between members of the same consolidated group.

Under the final regulations, three requirements must be satisfied in order for acquisitions of used property to qualify for bonus depreciation (used property acquisition requirements):

(1) the property must not have been used by the taxpayer or a predecessor at any time before the acquisition (no prior use requirement);

(2) the acquisition of the property must satisfy Reg. Sec. 1.168(k)-2(b)(3)(iii)(A)(2), which requires that (i) the property was not acquired from a related person (within the meaning of Code Sec. 179(d)(2)(A) and Reg. Sec. 1.179-4(c)(1)(ii)) (related party requirement), (ii) as provided in Code Sec. 179(d)(2)(B), the property was not acquired by one component member of a controlled group from another component member of the same controlled group (component member requirement), and (iii) the basis of the property in the hands of the acquirer is not determined, in whole or in part, by reference to the adjusted basis in the hands of the transferor; and

(3) the acquisition of the property must meet the requirements of Code Sec. 179(d)(3) and Reg. Sec. 1.179-4(d) (concerning like-kind exchanges and involuntary conversions).

Consolidated Groups

The 2018 proposed regulations provide that a member of a consolidated group that acquires depreciable property is treated as having a prior depreciable interest in such property if the consolidated group had a depreciable interest at any time before the member's acquisition of the property (group prior use rule). For purposes of applying the no prior use requirement, a member is treated under the 2018 proposed regulations as having a depreciable interest in property before the time of its acquisition if, as part of a series of related transactions, the 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 (stock and asset acquisition rule). For purposes of applying these two rules, if the acquisition of property is part of a series of related transactions that also includes 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.

The 2019 proposed regulations make the following clarifications with respect to consolidated groups:

(1) The group prior use rule applies only to the acquisition of property by a member of a consolidated group. Thus, this rule should apply only as long as the consolidated group remains in existence, as determined under Reg. Sec. 1.1502-75(d) and other applicable law.

(2) The group prior use rule applies only as long as a corporation remains a member of a consolidated group. Therefore, when a member deconsolidates, it does not continue to be treated under that rule as having a depreciable interest in the property unless it actually owned such property.

(3) The stock and asset acquisition rule applies only when the member whose stock is acquired had an actual depreciable interest in the qualified property that also is acquired as part of the same series of related transactions. Accordingly, under the 2019 proposed regulations, the phrase "a corporation that had a depreciable interest in the property" refers only to a corporation that has such an interest without regard to the application of the group prior use rule.

Acquisitions of Property

The 2019 proposed regulations provide that a contract to acquire all or substantially all of the assets of a trade or business, or to acquire an entity (for example, a corporation, a partnership, or a limited liability company), is binding if it is enforceable under state law against the parties to the contract. The presence of a condition outside the control of the parties, including, for example, regulatory agency approval, will not prevent the contract from being a binding contract. Further, the fact that insubstantial terms remain to be negotiated by the parties to the contract, or that customary conditions remain to be satisfied, does not prevent the contract from being a binding contract. This proposed rule also applies to a contract for the sale of the stock of a corporation that is treated as an asset sale as a result of an election under Code Sec. 338.

The 2019 proposed regulations also address acquisitions of property that are not pursuant to a written binding contract. If such property is not self-constructed property, a qualified film, television, or live theatrical production, or a specified plant, then the acquisition date is the date on which the taxpayer paid or incurred more than 10 percent of the total cost of the property, excluding the cost of any land and preliminary activities such as planning and designing, securing financing, exploring, or researching. This 10-percent proposed rule is the same as the safe harbor provided in Reg. Sec. 1.168(k)-2(b)(5)(iv)(B)(2) of the final regulations for determining the acquisition date of self-constructed property. This proposed rule does not apply to the acquisition of a trade or business, or an entity.

Components of Larger Self-Constructed Property

The 2019 proposed regulations allow a taxpayer to elect to treat one or more components acquired or self-constructed after September 27, 2017, of certain larger self-constructed property as being eligible for bonus depreciation. The larger self-constructed property must be qualified property under Code Sec. 168(k)(2), as in effect before the enactment of the TCJA, for which the manufacture, construction, or production began before September 28, 2017. The election is not available for components of larger self-constructed property when such property is not eligible for any bonus depreciation deduction (for example, property described in Code Sec. 168(k)(9) and placed in service by the taxpayer in any tax year beginning after December 31, 2017, or qualified improvement property placed in service by the taxpayer after December 31, 2017).

The 2019 proposed regulations also provide rules regarding installation costs and the determination of the basis attributable to the manufacture, construction, or production before January 1, 2020, for longer production period property or certain aircraft property described in Code Sec. 168(k)(2)(B) or (C). Additionally, the 2019 proposed regulations provide the time and manner of making the election, and provide examples to illustrate the proposed rules. Proposed rules regarding the determination of the basis attributable to the manufacture, construction, or production before January 1, 2027, for longer production period property or certain aircraft property described in Code Sec. 168(k)(2)(B) or (C) are also provided.

A practitioner requested guidance on whether property acquired before September 28, 2017, by a trade or business described in Code Sec. 168(k)(9)(A) is eligible for bonus depreciation under Code Sec. 168(k) as in effect before the enactment of the TCJA. Another practitioner requested clarification on whether any of the costs of property acquired before September 28, 2017, pursuant to a written binding contract, and placed in service after 2017 are eligible for bonus depreciation under Code Sec. 168(k). The IRS responded that property acquired before September 28, 2017, is eligible for the bonus depreciation deduction provided by Code Sec. 168(k) as in effect before the enactment of the TCJA, provided such property is qualified property under Code Sec. 168(k), as in effect before the enactment of the TCJA. However, if the taxpayer makes the election described above for components acquired or self-constructed after September 27, 2017, those components are eligible for the bonus depreciation deduction under Code Sec. 168(k). Such election, however, does not apply to, among other things, property described in Code Sec. 168(k)(9) and placed in service in a tax year beginning after December 31, 2017.

Special Rules for Mid-Quarter Convention

The 2019 proposed regulations provide that in determining whether the mid-quarter convention under Code Sec. 168(d) and Reg. Sec. 1.168(d)-1 applies for a tax year under Code Sec. 168(d)(3) and Reg. Sec. 1.168(d)-1, the depreciable basis, as defined in Reg. Sec. 1.168(d)-1(b)(4), for the tax year the qualified property is placed in service by the taxpayer is not reduced by the allowed or allowable bonus depreciation deduction for that tax year.

Applicability Dates and Taxpayer Reliance

The 2019 proposed regulations apply to qualified property placed in service or planted or grafted, as applicable, by the taxpayer during or after the taxpayer's tax year that includes the date the regulations are published as final regulations. The 2019 proposed regulations also apply to components acquired or self-constructed after September 27, 2017, of larger self-constructed property for which the manufacture, construction, or production begins before September 28, 2017, and that is qualified property under Code Sec. 168(k)(2) as in effect before the enactment of the TCJA and placed in service by the taxpayer during or after the taxpayer's tax year that includes the date the regulations are published as final regulations.

A taxpayer may rely on the 2019 proposed regulations, in their entirety, for qualified property acquired and placed in service or planted or grafted, as applicable, after September 27, 2017, by the taxpayer during tax years ending on or after September 28, 2017. A taxpayer also may rely on the 2019 proposed regulations, in their entirety, for components acquired or self-constructed after September 27, 2017, of larger self-constructed property for which the manufacture, construction, or production begins before September 28, 2017, and that is qualified property under Code Sec. 168(k)(2) as in effect before the enactment of the TCJA and placed in service by the taxpayer during tax years ending on or after September 28, 2017. If a taxpayer chooses to rely on the proposed regulations, the taxpayer must consistently apply all rules of the proposed regulations.

For a discussion of the bonus depreciation rules, see Parker Tax ¶94,200.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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