Final Regulations on TCJA Bonus Depreciation Are a Mixed Bag

| 10/3/2019
Tax News Highlights Oct. 3
On Sept. 13, the U.S. Department of the Treasury and the IRS released final regulations addressing 100% bonus depreciation under IRC Section 168(k), which was enacted by the Tax Cuts and Jobs Act of 2017 (TCJA). On the same day, Treasury and the IRS also released proposed regulations on 100% bonus depreciation that address issues that were not addressed in previously released proposed regulations, such as rules for the interplay between the business interest expense limitation and bonus depreciation in the case of floor plan financing and rules for partnerships and consolidated groups. 

Proposed regulations on 100% bonus depreciation initially were issued on Aug. 8, 2018. Taxpayers were permitted to rely on the proposed regulations until publication of final regulations, provided they apply the proposed regulations consistently. The final regulations adopt the proposed regulations with modifications that generally are taxpayer favorable. Nevertheless, two issues addressed in the final regulations might cause some frustration.

Qualified improvement property “glitch” not fixed

Due to an apparent drafting error in the TCJA, qualified improvement property is not eligible for 100% bonus depreciation. Commenters suggested that Treasury and the IRS fix the error through regulations or other guidance. In the preamble to the final regulations, Treasury and the IRS explain that the error can be fixed only through legislative action by Congress. In the current political climate, however, it is uncertain whether tax legislation will be enacted any time soon.

Relief for self-constructed property comes too late for some; amended return or method change might be warranted

Generally, a taxpayer is eligible for 100% bonus depreciation if all of the following apply:

  • The depreciable property is a specific type.
  • The original use of the property commences with the taxpayer.
  • Used property meets the acquisition requirements.
  • The property is placed in service within a particular time period.
  • The property is acquired after Sept. 27, 2017, or acquired pursuant to a binding written contract entered into after that date.

Section 13201(h) of the TCJA increased the bonus depreciation rate from 40% to 100% for property acquired after Sept. 27, 2017, and placed into service after Dec. 31, 2017. Section 13201(h) also states that property is not considered acquired after the date on which a written binding contract is entered into. 

IRC Section 168(k) as in effect prior to the TCJA included a written binding contract acquisition rule similar to the rule in Section 13201 of the TCJA. However, the pre-TCJA regulations stated that in the case of self-constructed property, the acquisition date rules regarding a written binding contract would be treated as met if the taxpayer began construction of the property after the applicable effective date. The pre-TCJA regulations also clarified that construction was considered to have begun when physical work of a significant nature had begun. Furthermore, the pre-TCJA regulations provided a safe harbor whereby physical work of a significant nature would not be considered to have begun for purposes of determining when construction began until more than 10% of the total cost of the property (excluding preliminary activities) was paid or incurred. 

The proposed TCJA bonus depreciation regulations published in August 2018 eliminated the special rule for self-constructed property where the property was constructed on behalf of the taxpayer by a third party. As a result, all property constructed by a third party under a written binding contract entered into before Sept. 28, 2017, would be 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 10% safe harbor, to the written binding contract rule. 

Many taxpayers filed their 2018 returns on or before the release date of the final regulations reinstating the pre-TCJA self-constructed property exception and safe harbor. If a taxpayer relied on the bonus depreciation proposed regulations to file its returns, it 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, the taxpayer might be eligible for the 100% bonus depreciation rate for this property. 

Procedural options

A taxpayer that has filed its 2018 return claiming the 40% bonus depreciation rate for self-constructed property but that is eligible under the final regulations to claim bonus depreciation at the 100% rate has two options to take advantage of the enhanced rate of recovery: Either amend the 2018 return or file an accounting method change with its 2019 return for the change in bonus depreciation rate. For many taxpayers, filing an accounting method change might be preferable.

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