On Sept. 13, the U.S. Department of the Treasury and the IRS released both final and proposed regulations regarding bonus depreciation. A hearing on the 2019 proposed regulations is scheduled for Nov. 13, 2019. The final regulations adopt portions of the proposed regulations on bonus depreciation issued in 2018. For dealers with floor plan financing, the newly issued guidance is mostly positive news.
The Tax Cuts and Jobs Act of 2017 (TCJA) increases the bonus depreciation rate from 40% to 100% for property acquired after Sept. 27, 2017, and placed into service after Dec. 31, 2017. The TCJA also disallows bonus depreciation if the floor plan financing interest exception applies. The 2018 proposed regulations did not address the interplay between the exception to the interest limitation for floor plan financing and bonus depreciation, resulting in significant uncertainty for dealers.
The 2019 proposed regulations clarify that dealers can claim bonus deprecation if all business interest expense, including floor plan financing interest, does not exceed the general 30% business interest expense limitation. This shift puts dealers on equal footing with taxpayers that do not have floor plan interest. Furthermore, the 2019 proposed regulations provide that eligibility for bonus depreciation is determined annually. Therefore, a dealer that exceeds the 30% interest limitation and deducts 100% of floor plan interest is prohibited from claiming bonus deprecation only for that one year.
The 2019 proposed regulations specifically state that claiming floor plan interest is not optional. Thus, if all business interest expense, including floor plan financing interest, exceeds the general 30% business interest expense limitation by any amount (even $1), the dealer will not be eligible to claim bonus deprecation during that tax year. This is not consistent with an example in the TCJA Blue Book, which indicates that a taxpayer can choose to carry forward floor plan interest to a subsequent year to avoid exceeding the 30% business interest limitation in the current year, thereby allowing the taxpayer to claim bonus depreciation. Some dealers that filed their 2018 tax return before the 2019 proposed regulations were released relied on the example in the Blue Book to carry forward excess floor plan interest to 2019 and claim bonus deprecation in 2018. Treasury and the IRS are aware of this issue and are considering whether special rules are needed.
Additionally, the 2019 proposed regulations provide that a lessor leasing property to a trade or business with floor plan financing is not prohibited from claiming bonus deprecation. Prior to the 2019 proposed regulations there was concern that dealers with rental real estate entities that lease dealership facilities to the related dealership entities might be prohibited from claiming bonus depreciation.
Until final regulations are published, dealers may rely on the 2019 proposed regulations for qualified property acquired and placed in service after Sept. 27, 2017, provided the proposed regulations are applied in their entirety. Therefore, dealers whose 2018 business interest expense, including floor plan financing interest, did not exceed the 30% interest limitation and that did not claim bonus depreciation should consider whether to file an amended tax return for 2018 to claim bonus depreciation. Dealers taxed as partnerships should be aware that under the new partnership audit rules, adjustments to an already-filed Form 1065 must be made under the administrative adjustment procedures. These rules are complex and might even delay the partners’ ability to take advantage of any additional tax savings resulting from following the 2019 proposed regulations.
While it seemed clear based on previously available guidance that the use of the floor plan interest exclusion would make dealers ineligible for bonus depreciation, some taxpayers nevertheless attached an irrevocable election out of bonus deprecation to their 2018 income tax return. Such an election out of bonus depreciation generally prevents dealers from amending their 2018 returns to rely on the 2019 proposed regulations and claim bonus depreciation without filing a costly private letter ruling. Treasury and IRS are considering whether relief from filing a private letter ruling is warranted in this situation.
The proposed TCJA bonus depreciation regulations published in August 2018 eliminated the pre-TCJA special rule for self-constructed property when the property was constructed on behalf of the taxpayer by a third party. As a result, under the 2018 proposed regulations, all property constructed by a third party under a written binding contract entered into before Sept. 28, 2017, was ineligible for the 100% bonus depreciation rate. In response to comments, the final regulations reverse course and add back the pre-TCJA self-constructed asset exception, including the safe harbor, to the written binding contract rule.
Many taxpayers filed their 2018 returns on or before the release date of the final regulations, which reinstated the pre-TCJA self-constructed property exception and safe harbor. These taxpayers would have claimed a 40% bonus depreciation rate for eligible self-constructed property placed into service after Sept. 27, 2017, if there was a written binding contract with respect to such property entered into on or before Sept. 27, 2017. However, under the self-constructed property exception and safe harbor reinstated under the final regulations, those taxpayers might be eligible for the 100% bonus depreciation rate for such property. Dealers should assess when their property would be considered acquired for the purposes of applying the 40% or 100% bonus depreciation rules. These rules do not apply to dealers not eligible for bonus depreciation due to the use of the floor plan interest exception.
Interplay between the business interest limitation and bonus depreciation in the case of floor plan financing
The business interest limitation generally restricts the deduction for business interest to 30% of the taxpayer’s adjusted taxable income for the year but provides an exception for floor plan financing interest. For those eligible under this rule, an unlimited amount of floor plan financing interest is deductible.The Tax Cuts and Jobs Act of 2017 (TCJA) increases the bonus depreciation rate from 40% to 100% for property acquired after Sept. 27, 2017, and placed into service after Dec. 31, 2017. The TCJA also disallows bonus depreciation if the floor plan financing interest exception applies. The 2018 proposed regulations did not address the interplay between the exception to the interest limitation for floor plan financing and bonus depreciation, resulting in significant uncertainty for dealers.
The 2019 proposed regulations clarify that dealers can claim bonus deprecation if all business interest expense, including floor plan financing interest, does not exceed the general 30% business interest expense limitation. This shift puts dealers on equal footing with taxpayers that do not have floor plan interest. Furthermore, the 2019 proposed regulations provide that eligibility for bonus depreciation is determined annually. Therefore, a dealer that exceeds the 30% interest limitation and deducts 100% of floor plan interest is prohibited from claiming bonus deprecation only for that one year.
The 2019 proposed regulations specifically state that claiming floor plan interest is not optional. Thus, if all business interest expense, including floor plan financing interest, exceeds the general 30% business interest expense limitation by any amount (even $1), the dealer will not be eligible to claim bonus deprecation during that tax year. This is not consistent with an example in the TCJA Blue Book, which indicates that a taxpayer can choose to carry forward floor plan interest to a subsequent year to avoid exceeding the 30% business interest limitation in the current year, thereby allowing the taxpayer to claim bonus depreciation. Some dealers that filed their 2018 tax return before the 2019 proposed regulations were released relied on the example in the Blue Book to carry forward excess floor plan interest to 2019 and claim bonus deprecation in 2018. Treasury and the IRS are aware of this issue and are considering whether special rules are needed.
Additionally, the 2019 proposed regulations provide that a lessor leasing property to a trade or business with floor plan financing is not prohibited from claiming bonus deprecation. Prior to the 2019 proposed regulations there was concern that dealers with rental real estate entities that lease dealership facilities to the related dealership entities might be prohibited from claiming bonus depreciation.
Until final regulations are published, dealers may rely on the 2019 proposed regulations for qualified property acquired and placed in service after Sept. 27, 2017, provided the proposed regulations are applied in their entirety. Therefore, dealers whose 2018 business interest expense, including floor plan financing interest, did not exceed the 30% interest limitation and that did not claim bonus depreciation should consider whether to file an amended tax return for 2018 to claim bonus depreciation. Dealers taxed as partnerships should be aware that under the new partnership audit rules, adjustments to an already-filed Form 1065 must be made under the administrative adjustment procedures. These rules are complex and might even delay the partners’ ability to take advantage of any additional tax savings resulting from following the 2019 proposed regulations.
While it seemed clear based on previously available guidance that the use of the floor plan interest exclusion would make dealers ineligible for bonus depreciation, some taxpayers nevertheless attached an irrevocable election out of bonus deprecation to their 2018 income tax return. Such an election out of bonus depreciation generally prevents dealers from amending their 2018 returns to rely on the 2019 proposed regulations and claim bonus depreciation without filing a costly private letter ruling. Treasury and IRS are considering whether relief from filing a private letter ruling is warranted in this situation.
Relief for self-constructed property
Under the TCJA, property acquired and placed in service after Sept. 27, 2017, generally is eligible for 100% bonus depreciation. The pre-TCJA rules for 40% bonus depreciation provided that for self-constructed property, the date of acquisition generally is the date construction begins. However, the pre-TCJA rules contain an exception for property constructed on behalf of a taxpayer by a third party, as well as a generally favorable safe harbor.The proposed TCJA bonus depreciation regulations published in August 2018 eliminated the pre-TCJA special rule for self-constructed property when the property was constructed on behalf of the taxpayer by a third party. As a result, under the 2018 proposed regulations, all property constructed by a third party under a written binding contract entered into before Sept. 28, 2017, was ineligible for the 100% bonus depreciation rate. In response to comments, the final regulations reverse course and add back the pre-TCJA self-constructed asset exception, including the safe harbor, to the written binding contract rule.
Many taxpayers filed their 2018 returns on or before the release date of the final regulations, which reinstated the pre-TCJA self-constructed property exception and safe harbor. These taxpayers would have claimed a 40% bonus depreciation rate for eligible self-constructed property placed into service after Sept. 27, 2017, if there was a written binding contract with respect to such property entered into on or before Sept. 27, 2017. However, under the self-constructed property exception and safe harbor reinstated under the final regulations, those taxpayers might be eligible for the 100% bonus depreciation rate for such property. Dealers should assess when their property would be considered acquired for the purposes of applying the 40% or 100% bonus depreciation rules. These rules do not apply to dealers not eligible for bonus depreciation due to the use of the floor plan interest exception.
