Over the past several decades, a trend in U.S. tax law has allowed businesses to recover the cost of capital investments more quickly to incentivize economic growth. So-called straight-line tax depreciation—i.e., where an equal amount of the cost basis is deducted over the useful life of the asset—generally has been replaced by regimes favoring accelerated depreciation, in which businesses can deduct more cost basis in early years. The Tax Reform Act of 1986, P.L. 99-514, maintained this trend when it established the modified accelerated cost recovery system (MACRS), which is still in use today.
In 2002, with the enactment of the Job Creation and Worker Assistance Act, P.L. 107-147, businesses could accelerate deductions for an even larger portion of their capital expenditures. So-called bonus depreciation—provided for by Sec. 168(k)—is deducted first during the tax year in which eligible property is placed in service, followed by the MACRS deduction (which is determined after reducing the original cost basis of the property by the bonus depreciation amount). The introductory bonus rate of 30% applied to eligible property acquired after Sept. 10, 2001 (retroactive from passage of P.L. 107-147), and placed in service before Jan. 1, 2005.
The following year, the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), P.L. 108-27, increased the bonus rate to 50% for eligible property originally used after May 3, 2003, and placed in service before Jan. 1, 2005. After JGTRRA, there was not an extension until 2008 and, as a result, the provision lapsed for three years. Bonus depreciation of 50% was again revived by the Economic Stimulus Act of 2008, P.L. 110-185, for eligible property acquired by the taxpayer after Dec. 31, 2007, and placed in service before Jan. 1, 2009. The placed-in-service date was extended to Jan. 1, 2010, by the American Recovery and Reinvestment Act of 2009, P.L. 111-5. The bonus rate reached 100% for assets acquired after Sept. 8, 2010, and before Jan. 1, 2012, and placed in service before Jan. 1, 2012, pursuant to the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, P.L. 111-312 (100% bonus depreciation is often referred to as "full expensing" because the purchasing business deducts the entire cost basis from its taxable income in year 1).
Upon the expiration of the 100% bonus rate, the 50% bonus depreciation was extended to property acquired and placed in service through the end of 2013 by the American Taxpayer Relief Act of 2012, P.L. 112-240. Although two bills passed the House of Representatives in 2014 that would have permanently extended the 50% rate, the Senate did not consider either piece of legislation. The Senate Finance Committee, for its part, reported a bill on April 3, 2014, that would have extended the 50% rate through 2015, but the bill never received a vote on the Senate floor. At the end of 2014, the House and Senate finally agreed on the Tax Increase Prevention Act, P.L.113-295, which retroactively extended the 50% bonus depreciation to property acquired and placed in service before 2015.
The PATH Act
The current state of bonus depreciation was determined as part of the Protecting Americans From Tax Hikes (PATH) Act of 2015, P.L. 114-113, which extended bonus depreciation to property acquired and placed in service before 2020, but phases down the bonus rate after 2017. Eligible property placed in service between Jan. 1, 2015, and Dec. 31, 2017, will remain eligible for the 50% rate. Assets placed in service during 2018 will be eligible for a 40% bonus rate, and assets placed in service during 2019 will be eligible for a 30% rate. With limited exceptions, bonus depreciation is not scheduled to be available for property placed in service after Dec. 31, 2019. The limited exceptions apply to certain transportation property, as defined in Sec. 168(k)(2)(B)(iii) (i.e., tangible personal property used in the trade or business of transporting persons or property) and certain other property having longer production periods, which under Secs. 168(k)(2)(B)(i)(IV) and 263A(f)(1)(B)(iii) must have a recovery period of at least 10 years and cost more than $1 million. These types of property will remain eligible for the 30% bonus rate if placed in service before Jan. 1, 2021, but only to the extent the adjusted basis is attributable to property manufactured, constructed, or produced before Jan. 1, 2020.
As it repeatedly extended bonus depreciation, Congress also sought ways to incentivize corporations in net operating loss positions to make capital investments, so it enacted rules, starting with the Housing and Economic Recovery Act of 2008, P.L. 110-289, that allowed certain corporations to elect to forgo bonus depreciation allowances in exchange for the opportunity to effectively monetize (in the form of a refundable tax credit) a portion of their unused alternative minimum tax (AMT) credits or research tax credits generated prior to 2006. Like the bonus depreciation rate, the existence of this election under Sec. 168(k)(4) and its parameters fluctuated over the years, and it was most recently extended by the PATH Act to allow monetization of unused AMT credits (but not research credits) in lieu of the electing corporation's claiming bonus depreciation, for tax years ending before Jan. 1, 2020 (or Jan. 1, 2021, in the case of certain transportation and longer-lived property).
Eligible Property: PATH Act Changes
In addition to extending bonus depreciation and phasing out the bonus rate, the PATH Act made several changes to the types of eligible property under Sec. 168(k)(2). As modified, the section has three requirements. First, the property must fall into one of four categories of "qualified property": (1) MACRS property with a recovery period of 20 years or less; (2) computer software as defined in Sec. 167(f)(1)(B); (3) water utility property; or (4) qualified improvement property (defined in Sec. 168(k)(3)). Second, the original use of the property must commence with the taxpayer, meaning it must be new property (with certain exceptions for leased property). Third, the property must generally be placed in service by the taxpayer before Jan. 1, 2020.
"Qualified improvement property" is a new type of bonus-eligible property defined in Sec. 168(k)(3)(A) as "any improvement to an interior portion of a building which is nonresidential real property if such improvement is placed in service after the date such building was first placed in service." However, Sec. 168(k)(3)(B) lists three improvements that do not qualify for bonus depreciation: (1) an enlargement of the building, (2) any elevator or escalator, or (3) the internal structural framework of the building.
Prior to the PATH Act, another category of bonus-eligible property had been "qualified leasehold improvement property" (emphasis added). In addition to removing the requirement that the underlying property be leased for an improvement to be bonus-eligible, another important PATH Act distinction with respect to improvement property relates to the timing of when such assets must be placed in service. Under pre-PATH Act law, qualified leasehold improvement property had to be placed in service at least three years after the building itself was placed in service. However, there is no such limitation for qualified improvement property under the PATH Act. Consequently, the cost of certain improvements to nonresidential real property are now allowed to be recovered faster for tax purposes, even if the improvements are placed in service immediately after the building itself was placed in service in its original form.
Other PATH Act Changes
In addition to expanding the categories of property eligible for bonus depreciation, the PATH Act modified several other rules, including changes to the Sec. 168(k)(4) regime allowing corporations to monetize AMT credits in lieu of claiming bonus depreciation. Prior to the PATH Act, the amount of the refundable credit allowed under Sec. 168(k)(4) for any tax year generally could not exceed 6% of the unused AMT credits generated from pre-2006 years. Among other changes, the PATH Act enhanced the benefits potentially available to a corporation making a Sec. 168(k)(4) election, by generally allowing the corporation to monetize in any one tax year up to 50% of its unused AMT credits generated from pre-2016 years.
The PATH Act also extended bonus depreciation to certain fruit- and nut-bearing plants before such plants are placed in service. Such plants typically are not considered placed in service until they reach an income-producing stage (i.e., they begin producing fruits or nuts), which can take several years from the date of planting or grafting. Thus, costs incurred up to that point—referred to as "pre-productive costs"—were not yet depreciable or eligible for bonus depreciation. The PATH Act relaxed this rule by adding Sec. 168(k)(5)(A), which provides that specified plants planted or grafted before Jan. 1, 2020, in the ordinary course of a taxpayer's farming business will be eligible for bonus depreciation, subject to the same rate phaseout as other property—that is, 50% for plants planted or grafted through 2017, 40% in 2018, and 30% in 2019—without regard to whether the plants have reached an income-producing stage. However, when such plants are placed in service, the basis must be reduced by the bonus depreciation claimed.
Finally, the PATH Act made permanent the 15-year recovery period for qualified leasehold improvement property, along with related provisions for qualified restaurant property and qualified retail improvement property. These rules retain the definitions of such property, notwithstanding the change in the bonus depreciation rules.
Possible Tax Reform Impact
The election of a Republican president and the continuation of Republican majorities in both houses of Congress have placed a renewed focus on tax reform, including the possibility of major changes to the tax depreciation rules. For example, House Republicans released a tax reform "Blueprint" in June 2016, which, in addition to calling for lower business tax rates, proposed to replace the current depreciation system with a permanent full "expensing" regime. President Donald Trump also addressed tax depreciation during the 2016 campaign, advocating a tax system in which firms engaged in U.S. manufacturing could elect to fully expense capital investments. In both the House Republican Blueprint and the Trump platform, the ability to fully expense eligible property is accompanied by proposals to limit deductions for business interest expense. Trump and congressional Republicans have discussed tax reform as a top priority—one they hope to achieve in 2017.
In view of the scheduled phaseout of bonus depreciation under current law, as well as tax reform discussions between Congress and the White House that could have major ramifications for cost recovery rules, taxpayers will want to weigh at least two possible scenarios when considering the timing of planned capital investments. If one believes the House Republican Blueprint—after being drafted into legislative text—may pass in its original form, the transition to full expensing (if enacted on an immediate basis) could mean taxpayers should wait to invest in capital assets, as they will be able to deduct the full cost in the year the assets are placed in service. However, if one believes the Blueprint will not become law, or may pass but without full expensing, taxpayers may be better served by placing bonus-eligible property in service prior to the end of 2017, before the rate phases down from 50% to 40% under the PATH Act.
Budgetary factors, as well as a host of other political and policy considerations, will have a bearing on the final composition of any tax reform legislation. As a result, taxpayers will want to pay close attention to the tax reform debate in 2017 when weighing, among other things, the timing of their capital investments.
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Alex Brosseau is a senior manager in the Tax Policy Group of Deloitte Tax LLP’s Washington National Tax office.
For additional information about these items, contact Mr. Brosseau at 202-661-4532 or email@example.com.
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