On Aug. 8, the IRS and the U.S. Department of the Treasury issued proposed regulations addressing the new 100 percent bonus depreciation adopted by the Tax Cuts and Jobs Act (TCJA). The proposed regulations largely incorporate the existing bonus depreciation regulations with modifications necessary for the TCJA.
The proposed regulations fail to address an important deduction that taxpayers were hoping would be included, and they cover other significant elements.
Qualified improvement property
Before tax reform, improvements to real property classified as qualified leasehold improvements, qualified retail improvements, and qualified restaurant property had a 15-year recovery period and were eligible for 50 percent bonus depreciation. The conference committee report indicated that Congress intended to combine the three types of property into a new category of real estate improvements called qualified improvement property (QIP) that would be eligible for a 15-year life and bonus depreciation. QIP includes certain improvements to an interior portion of a building that is nonresidential real property. However, due to an apparent drafting error, the statute did not extend the eligibility of QIP beyond Dec. 31, 2017. While many had hoped that the regulations would grant QIP eligibility for 100 percent bonus depreciation, this was not the case.
100 percent bonus depreciation for used property
The TCJA eliminated the original-use requirement, allowing used property to be eligible for bonus depreciation. To avoid potential abuses the statute incorporated the rules of Section 179 that prevent property acquired from related parties from qualifying for 100 percent bonus depreciation. Under the statute, property can’t be acquired from a related party, and the purchaser’s basis in the property is not determined in whole or in part by reference to the adjusted basis of such property in the hands of the person from whom acquired. Furthermore, the proposed regulations point out that the property must not have been used by the taxpayer or a predecessor at any time prior to the acquisition. The language “was not used by the taxpayer at any time prior to such acquisition” caused concern that a lessee would be prohibited from claiming bonus depreciation on property it acquires that it previously had leased. However, the proposed regulations point out that the term “used” depends on whether there was a depreciable interest in the property. Therefore, property subject to an operating lease generally would be eligible for bonus depreciation if subsequently acquired by its lessee.
Under the proposed regulations:
- 100 percent bonus depreciation generally is available for increases in basis attributable to Section 743 adjustments.
- 100 percent bonus depreciation is not available for Section 734 adjustments.
- 100 percent bonus depreciation is not available for remedial allocations under Section 704(c).
The proposed regulations confirm that 100 percent bonus depreciation is available for acquisitions using Sections 338(h)(10) and 336(e).
Electing real property trades or businesses
The TCJA allowed an exclusion from the interest deduction limitation rules for a real property trade or business that so elects and required a taxpayer making the election to depreciate its nonresidential real property, residential rental property, and QIP under the alternative depreciation system (ADS). Property required to be depreciated under ADS is not eligible for bonus depreciation. Taxpayers hoped to receive guidance on the implementation of this rule in cases when a taxpayer makes the election in a year after it already has taken bonus depreciation on any aforementioned real property (assuming the drafting error regarding QIP has been corrected). Taxpayers still want to know if there will be a requirement to recapture bonus depreciation previously taken in this scenario. Unfortunately, the proposed regulations do not provide any procedural guidance on this topic.
Overall, the proposed regulations are a mixed bag but a step in the right direction. They provide much-needed clarification in areas such as partnership transactions and defer guidance on topics such as QIP and electing real estate trade or business rules.