Final bonus depreciation regulations released

| 9/24/2020
Final bonus depreciation regulations released

On Sept. 21, the U.S. Department of the Treasury and the IRS released a second set of final regulations implementing changes to bonus depreciation under IRC Section 168(k), which was enacted by the Tax Cuts and Jobs Act of 2017 (TCJA). The first set of final regulations was published in September 2019.

The 2020 final regulations address two issues that might be important to automobile dealers:

  • The interplay of bonus depreciation and the rules under IRC Section 163(j) for taxpayers with floor plan financing interest
  • The definition of qualified improvement property (QIP)

Interplay of bonus depreciation and floor plan financing interest

The business interest limitation under IRC Section 163(j) 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. Under IRC Section 168(k), bonus depreciation is not allowed if the floor plan financing interest exception applies.

The 2020 final regulations clarify that if all business interest expense including floor plan financing interest does not exceed the general limitation under IRC Section 163(j), the taxpayer can claim bonus depreciation. The 2020 final regulations also provide that if all business interest expense including floor plan financing interest exceeds the general limitation under IRC Section 163(j), bonus depreciation is not allowed. These rules do not allow taxpayers with floor plan financing interest to choose to limit the amount of floor plan financing interest they take into account to benefit from bonus depreciation.

Furthermore, the 2020 final regulations provide that eligibility for bonus depreciation relative to floor plan financing interest is determined annually. Thus, a taxpayer with floor plan financing interest may be ineligible to claim bonus depreciation in one tax year but eligible to claim it in the next tax year if all business interest does not exceed the general limitation.

The TCJA Bluebook includes a more flexible interpretation of the interaction between floor plan financing interest and bonus depreciation. The TCJA Bluebook interpretation allows taxpayers to claim bonus depreciation even if business interest including floor plan financing interest exceeds the general limitation under IRC Section 163(j). The preamble to the 2020 final regulations indicates that Treasury and the IRS recognize that some taxpayers with floor plan financing interest might have relied on the Bluebook interpretation to claim bonus depreciation that is not permitted under the regulations, and they intend to issue guidance that will address transitional relief for such taxpayers.

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QIP definition

The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) corrected a drafting error in the TCJA, thereby providing that QIP is classified as 15-year property and is eligible for bonus depreciation. However, the CARES Act amended the definition of QIP to provide that to qualify as QIP the improvement must be “made by the taxpayer.” These changes are effective as if included in the TCJA and, therefore, apply to property placed in service on or after Jan. 1, 2018.

Inclusion of the words “made by the taxpayer” in the QIP definition created confusion for taxpayers with a number of specific fact patterns. The final regulations clarify that “made by the taxpayer” is satisfied if the improvement is made, manufactured, constructed, or produced for the taxpayer by another person under a written contract.

The final regulations also clarify that if the taxpayer acquires nonresidential real property in a taxable transaction and such property includes an improvement previously placed in service by the seller of the property, the improvement is not treated as “made by the taxpayer” and, therefore, is not the buyer’s QIP.

Furthermore, the final regulations provide that property acquired in a nonrecognition transaction, such as under IRC Sections 351 or 721, may be treated as “made by the taxpayer,” but it is not eligible for bonus depreciation because the acquisition does not satisfy the used property acquisition requirements under the regulations.

Looking ahead

Transition relief for taxpayers who relied on the Bluebook is coming. In addition, the final regulations that were released to the public have not yet been filed with the Federal Register. The regulations could have changes when they actually are filed with the Federal Register, though any changes are unlikely to be significant. Taxpayers should consult with their tax advisers to keep abreast of the most recent guidance on bonus depreciation.

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Joseph Magyar
Joseph Magyar
Managing Partner, Retail Dealer
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Edward Meyette
Partner