Editor: Lori Anne Johnston, CPA, J.D.
The bonus depreciation rules of Sec. 168(k) were expanded by the 2017 tax reform law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97. The TCJA granted taxpayers the ability to claim immediate expensing of the cost of certain qualified property. Taxpayers generally are eligible for this bonus depreciation benefit only with respect to their first use of the qualified property (Sec. 168(k)(2)). Proposed regulations issued in September 2019 (REG-106808-19) address the application of certain aspects of Sec. 168(k), including certain transactions between taxpayers that are members of a consolidated group — a group of corporations that file a consolidated federal income tax return. This discussion focuses on the proposed regulations' taxpayer-favorable approach to determining when a member of a consolidated group that first acquires property from another group member, and then exits the group, will be eligible for bonus depreciation with respect to that property.
Sec. 168(k) generally
Generally, under Sec. 168(k) taxpayers are eligible for a deduction equal to the applicable percentage of the unadjusted depreciable basis of certain qualified property acquired after Sept. 27, 2017, and placed in service after Sept. 27, 2017, and before Jan. 1, 2027. Specifically, the applicable percentage is 100% for property placed in service between Sept. 28, 2017, and Dec. 31, 2022, with annual 20% reductions in the applicable percentage scheduled between 2023 and 2027 (Sec. 168(k)(6)). Sec. 168(k) is currently scheduled to phase out entirely in 2027 for many types of property, and otherwise in 2028. Taxpayers may also elect not to apply Sec. 168(k) to a particular class of property for a tax year (Sec. 168(k)(7)).
A prominent, taxpayer-favorable aspect of Sec. 168(k) added by the TCJA is that used property may qualify for bonus depreciation under Sec. 168(k) (Secs. 168(k)(2)(A)(ii) and 168(k)(2)(E)(ii)). For used property to qualify for bonus depreciation under Sec. 168(k), Regs. Secs. 1.168(k)-2(b)(3)(iii)(A) and (B) require that the property was not used by the taxpayer or a predecessor at any time prior to its acquisition. This "no prior use requirement" prohibits a taxpayer who previously used property from claiming bonus depreciation after reacquiring the property. The proposed regulations address the application of this no-prior-use requirement to consolidated groups of corporations.
No-prior-use rule for consolidated taxpayers
Generally, under Prop. Regs. Sec. 1.168(k)-2(b)(3)(v)(A), if a member of a consolidated group acquires depreciable property in which the consolidated group had a depreciable interest at any time prior to the member's acquisition of the property, the member is treated as having had a depreciable interest in the property prior to the acquisition. This prevents the group from claiming bonus depreciation under Sec. 168(k) with respect to the acquired property. A consolidated group is treated as having a depreciable interest in property during the time any current or former member of the consolidated group had a depreciable interest in the property while a member of the consolidated group (Prop. Regs. Sec. 1.168(k)-2(b)(3)(v)(A)).
Two examples were included in the proposed regulations that explain how this rule is applied. In the first example, B and C are both members of consolidated group P. C owns Equipment #1, which it sells to B in 2018. The example explains that B's acquisition of Equipment #1 from C is not eligible for immediate expensing under Sec. 168(k) because: (1) the taxpayers are related (this item does not discuss the related-party property-acquisition rules under Sec. 168(k)); and (2) B is treated as previously having a depreciable interest in Equipment #1 as a result of being a part of a consolidated group while C, also a member of the consolidated group, had a depreciable interest in Equipment #1 (Prop. Regs. Sec. 1.168(k)-2(b)(3)(vii)(Z), Example (26)).
It comes as no surprise that based on the proposed regulations, B would be denied the ability to claim bonus depreciation with respect to its acquisition of property from a related taxpayer. A second example illustrates the breadth of these rules. In the example, D and E are both corporations and members of consolidated group P. In year 1, D sells Equipment #2 to BA, a taxpayer that is unrelated to D or any other member of the P consolidated group. In a later tax year in an unrelated transaction, BA sells Equipment #2 to E. The example explains that E's acquisition of Equipment #2 does not satisfy the no-prior-use requirement and is therefore not eligible for the additional first-year depreciation deduction under Sec. 168(k) (Prop. Regs. Sec. 1.168(k)-2(b)(3)(vii)(AA), Example (27)).
As the second example illustrates, consolidated taxpayers must have some knowledge of the history of the qualified property they acquire in order to determine eligibility for bonus depreciation. However, the property's relevant history for purposes of the no-prior-use requirement generally is limited to the five calendar years immediately prior to the taxpayer's current placed-in-service year of the property (Regs. Sec. 1.168(k)-2(b)(3)(iii)(B)(1)).
Rules to handle sales of property to departing members
It is not uncommon for a member of a consolidated group to be acquired by an unrelated party and depart the group. A member's departure by acquisition may raise bonus depreciation issues since the member may be acquired by actual or deemed asset purchase. Additionally, the departing member may acquire assets from one or more members that remain in the consolidated group after the acquisition. The proposed regulations provide a framework for when a member of a consolidated group is sold to a third party.
Prop. Regs. Sec. 1.168(k)-2(b)(3)(v)(C) provides that if a member of a consolidated group (the "transferee member") acquires depreciable property from another member of the same group (the "transferor member") and, as part of the same series of related transactions that includes the acquisition of the depreciable property, the transferee member ceases to be a member of the consolidated group within 90 calendar days of the date of the acquisition, then:
1. The transferor member is treated as disposing of, and the transferee member is treated as acquiring, the depreciable property one day after the date on which the transferee member ceases to be a member of the consolidated group (the "deconsolidation date") for all federal income tax purposes; and
2. The transferee member is treated as placing the depreciable property in service not earlier than one day after the deconsolidation date.
A similar rule is provided in Prop. Regs. Sec. 1.168(k)-2(b)(3)(v)(D) for certain transactions involving Sec. 338 or Sec. 336(e) deemed asset sale elections. This rule applies when:
1. The transferee member first acquires the stock of another member of a consolidated group that holds depreciable property (the "target") in either a qualified stock purchase for which a Sec. 338 election is made or a qualified stock disposition for which a Sec. 336(e) election is made; and
2. Both the transferee member and the target cease to be members of the consolidated group within 90 calendar days of the acquisition/disposition date.
In these circumstances, the acquisition/disposition date is treated as the date that is one day after the deconsolidation date, and new target is treated as placing the depreciable property in service not earlier than one day after the deconsolidation date. This allows the target to take bonus depreciation under Sec. 168(k) upon acquisition by a purchaser. Additional examples in the proposed regulations illustrate the mechanics of these rules.
The proposed regulations' rules for predeparture intra-consolidated-group property sales differ from the general rules governing intercompany transactions between members of a consolidated group (see Regs. Sec. 1.1502-13). For qualified property, the proposed regulations have the taxpayer-favorable effect of enabling the unrelated acquirer to claim bonus depreciation. Taxpayers may rely on the proposed regulations now and need not wait for their finalization. More specifically, taxpayers may adopt the proposed regulations for qualified property acquired and placed in service after Sept. 27, 2017, during a tax year ending on or after Sept. 28, 2017, and ending before the taxpayer's tax year that includes the date the proposed regulations are finalized (Prop. Regs. Sec. 1.168(k)-2(h)(4)(ii)).
The proposed regulations do raise some questions. For example, their rules would apply to all depreciable property, not just Sec. 168(k) qualified property. As a result, they could complicate transactions that do not involve property eligible for bonus depreciation. In addition, the proposed regulations appear to disregard the intercompany sale of depreciable property to a departing member for an intervening period of up to 90 days — until the member buying the property departs the group. How the income and deductions produced by the property during that intervening period should be accounted for is not entirely clear.
A framework for proper planning
The proposed regulations' rules applicable to sales of qualified property to departing members of a consolidated group appear logical on their face. They allow for the preservation of potential benefits under Sec. 168(k) for a departing member of a consolidated group upon its sale to a third party, provided careful planning is undertaken to ensure that all steps of the transaction will be integrated.
Taxpayers and their advisers now have a framework (and work to do) to determine the availability of bonus depreciation following various transactions involving consolidated groups.
Lori Anne Johnston, CPA, J.D., is a manager, Washington National Tax for RSM US LLP.
For additional information about these items, contact Justin Trakimas (Justin.Trakimas@rsmus.com), and Stefan Gottschalk (Stefan.Gottschalk@rsmus.com).
Unless otherwise noted, contributors are members of or associated with RSM US LLP.