Bonus Depreciation Update: New Regulations Issued
On September 21, 2020, the IRS and Treasury Department released the second set of final regulations (the 2020 Final Regulations) regarding the first year (bonus) depreciation rules of Internal Revenue Code (“IRC”) Section 168(k). With some modifications, these final regulations adopt the proposed regulations issued in September 2019 and provide clarifying guidance on issues not addressed in the first set of final regulations, also issued in September 2019.
In general, taxpayers may rely on either these final or the proposed regulations issued in 2019 - but must consistently apply either the proposed or the final regulations in their entirety for subsequent taxable years.
What is bonus depreciation - and the effect of the Tax Cuts and Jobs Act (TJCA)?
Bonus depreciation allows taxpayers to write off a portion of the cost of qualifying business assets as depreciation in the year the asset was placed in service. The Tax Cuts and Jobs Act (TCJA) of 2017 made some amendments to bonus depreciation. The TCJA generally applies to depreciable business assets with a recovery period of 20 years or less and certain other property that were placed in service after September 27, 2017.
Amendments to bonus depreciation made by the TCJA include:
- Increasing the first-year bonus depreciation deduction from 50% to 100%.
- Expanding the property eligible for bonus depreciation to include used
- Extending the placed to service date from property placed in service before January 1, 2020 to before January 1, 2027 (and from before January 1, 2021, to before January 1, 2028 for longer production period property or certain aircraft property).
The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) amended a drafting error in the TCJA to provide that qualified improvement property (QIP) is classified as 15-year property thereby making QIP eligible for bonus depreciation deduction.
Highlights of the 2020 Final Regulations
What is “Qualified Improvement Property” (QIP)?
The 2020 final regulations modify the definition of “qualified improvement property” by requiring that the improvement be made by the taxpayer to reflect the technical correction included in the CARES Act. Under TCJA, QIP was treated as 39-year property and was not eligible for bonus depreciation. The CARES Act added QIP “made by the taxpayer” to the list of 15-year property and the 2020 final regulations adopt this change.
The improvement is “made by the taxpayer” if the taxpayer makes, manufactures, constructs, or produces the improvement for itself or if the improvement is made, manufactured, constructed, or produced for the taxpayer by another person under a written contract.
Five Year Safe Harbor
The 2019 final regulations provide that if property was previously owned by the taxpayer and later purchased again, the property can qualify for bonus depreciation if the taxpayer did not have a depreciable interest in the previous five years.
The 2020 final regulations amend and clarify this rule. In addition to the prior five calendar years, the lookback period includes the portion of the calendar year covering the period up to the placed-in-service date. In addition, the taxpayer and a predecessor are each subject to a separate lookback period.
Floor-Plan Financing - and the interplay between interest expense limitation & bonus depreciation
IRC Section 163(j) generally restricts the deduction for business interest to 30% of the taxpayer’s adjusted taxable income for the year plus the floor plan financing interest (typically applicable to equipment and car dealerships). In addition, when floor plan financing interest is deductible under this general rule bonus depreciation is not allowed.
Under the 2019 proposed regulations a taxpayer with floor-plan financing could not choose to limit its interest expense deductions in a given year in order to remain eligible for the additional first-year bonus depreciation.
The final regulations provide some clarification regarding the maximum amount of deductible business interest including floor plan financing, but do not allow taxpayer to choose to limit the amount of deductible floor plan financing interest in order to benefit from bonus depreciation. Also, the eligibility for bonus depreciation relative to floor plan financing interest is determined annually.
Partnership Lookthrough Rule
The Treasury Department and the IRS have determined that the complexity of applying the Partnership Lookthrough Rule would place a significant burden on both taxpayers and the IRS, and, therefore, the rule was withdrawn.
The 2020 final regulations offer guidance and clarification to both the proposed regulations and final regulations issued in 2019. The regulations cover additional specialized areas including application of the de-minimis rule, applying the mid-quarter convention, and a special election for components acquired or self-constructed after September 28, 2017.
In addition, consideration must be given to state conformity when calculating state depreciation. Not all states confirm to the federal bonus depreciation rules. Some states follow the Internal Revenue Code in its entirety, some states conform as of a certain date, some states conform with modifications, but many states completely decouple from federal bonus depreciation rules.
Please contact your Herbein tax advisor if you have any questions or need assistance with this matter.
Article contributed by Michele Burkins. Contact the author at firstname.lastname@example.org.