Editor: Greg A. Fairbanks, J.D., LL.M.
It seems to have become customary in recent years that new bonus depreciation regulations are released in the autumn. In November 2020, Treasury and the IRS issued bonus depreciation final regulations (T.D. 9916) that substantially modified the September 2019 proposed regulations in four areas:
- Partnership rules;
- Special rules that require testing of relationships when assets are transferred in a series of related transactions;
- Consolidated group rules, including transactions that involve a member that deconsolidates; and
- Rules for making a component election for self-constructed property.
Each of these four areas is discussed in more detail below.
As background, Congress made substantial amendments to Sec. 168(k)'s bonus depreciation rules in the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, such as expanding bonus depreciation to certain used property and Sec. 743(b) adjustments. In 2018, the IRS released the first set of proposed regulations on the subject. In response to comments received from taxpayers, the IRS issued the 2019 final and proposed regulations.
The IRS has also published procedures that address how taxpayers that implemented the 2018 and 2019 proposed bonus depreciation regulations can adopt the final rules. These taxpayers should assess the procedural options and their ability to take advantage of any favorable changes in the final regulations. Taxpayers should also carefully weigh the benefits of adopting the final regulations versus the 2019 proposed regulations for open tax years.
One of the biggest changes in the final regulations is the withdrawal of the partnership lookthrough rule. Under the 2019 proposed regulations, a partner would have been considered to have a depreciable interest in partnership property that was generally based on the partner's total allocated share of depreciation deductions for that property during the current and previous five calendar years. The rule, as proposed, could have created significant administrative and compliance burdens on both taxpayers and the IRS. For example, this rule would have limited the availability of bonus depreciation in a variety of transactions involving partnerships that result in basis increases for minority partners in a partnership, because it would require tracking of lookthrough ownership for the minority partners in the partnership.
To address the concerns, the final regulations rescind the proposed partnership lookthrough rule and, as a result, provide that a partner will not be treated as having a prior depreciable interest in partnership property solely by the reason of being a partner in a partnership. The IRS did not replace the rule because the it believes that the related-party rules under Sec. 179(d)(2), in conjunction with the series-of-related-transactions rule (discussed below), should prevent potential abuse while limiting the administrative burden on taxpayers and the IRS.
The final regulations also clarify that for Sec. 743(b) adjustments, an election out of bonus depreciation is made by the partnership for each partner's basis adjustment for each class of property. This means that each partner with a Sec. 743(b) adjustment could separately decide to elect out of bonus depreciation independently of one another, which provides flexibility to partners as they consider their own tax circumstances.
Even if a taxpayer chooses to apply the 2019 proposed regulations for a tax year beginning before Jan. 1, 2021, it should not apply the partnership lookthrough rule for such tax year because the rule has been withdrawn from the 2019 proposed regulations in its entirety. The withdrawal of the partnership lookthrough rule removes a significant obstacle to current or former partners' claiming bonus depreciation for property acquired in a variety of partnership transactions.
Series of related transactions
The 2019 proposed regulations provided that when assets are transferred in a series of related transactions, the transferee is required to test certain relationships in determining whether the assets are eligible for bonus depreciation when acquired. In general, the relationship between the parties under Sec. 179(d)(2)(A) or (B) is tested immediately after each step in the series, and between the original transferor and the ultimate transferee immediately after the final transaction in the series of transactions, similar to the rule to prevent the churning of assets under Sec. 197.
However, this rule left open several questions: (1) When does a taxpayer test its relationships? (2) What happens if a party in a series of transactions ceases to exist before the transactions are completed? (3) What happens if a party in a series of transactions comes into existence during the series of transactions?
The final regulations expand upon the proposed rule to address the questions above. A transferee tests its relationship either immediately before the first transfer of the property in the series or when the transferee acquires the property, and if the transferee is related to either its immediate transferor or the original transferor, then the transferee would be ineligible for bonus depreciation on otherwise qualified property. If a party ceases to exist before the series of transactions is completed, that party is deemed to exist until the final transaction in the series is completed, for the purposes of testing relatedness. Similarly, if a party comes into existence during the series of transactions, that party must test its relatedness to the original transferor and its immediate transferee when it receives the property. As a result, under the final regulations each transferee must test its relatedness with its immediate transferor and with the original transferor, regardless of whether it is formed or dissolved during the series of transactions.
Here is an illustration:
Example 1: A transfers qualified property to B; B then transfers the qualified property to C; then C finally transfers the qualified property to D. In this case, B would test its relatedness with A; C would test its relatedness with A and B; and D would test its relatedness with A and C.
Consider the following scenario where a party ceases to exist before the series of transactions is completed:
Example 2: Take the same facts as Example 1 but assume that A ceases to exist prior to C's transferring the qualified property to D. In this case, even though A ceases to exist, it is deemed to be still in existence for purposes of D's testing its relationships.
Certain requirements in the 2019 proposed regulations for used property to be eligible for bonus depreciation raised additional concerns for property acquired by a member of a consolidated group. These concerns included: (1) that property cannot have been used previously; (2) that property cannot have been used by a related party; and (3) that basis of the used property is not determined in whole or in part by reference to the adjusted basis of the transferor.
The final regulations significantly modify the 2019 proposed regulations for consolidated groups to provide additional rules for various transactions involving members of the consolidated group. Regs. Sec. 1.1502-68 addresses both the no-prior-use and the related-party requirements. It clarifies that the lookback period for the no-prior-use requirement is five calendar years and additionally clarifies the treatment of a series of related transactions involving both an asset acquisition and acquisition of stock of a member.
Additionally, under the 2019 proposed regulations, the IRS included a rule known as the "proposed consolidated asset acquisition rule" that addressed transfers of depreciable property between members of the same consolidated group. This rule ultimately was not included in the final regulations. Commenters pointed out, and the IRS agreed, that this rule would create uncertainty and raise implementation issues. In response, the IRS removed the rule, including the 90-day timing for the departure of the buying member of the group, in favor of a new construct.
More specifically, the final regulations adopt a "delayed bonus" approach that has no such timing requirement but has a simplified, narrow construct to allow bonus depreciation while not otherwise opening the door for other "new property" credits or incentives. The delayed-bonus approach treats the transferee member as: (1) selling the eligible property to an unrelated third party one day after the deconsolidation date for an amount equal to the member's basis in the eligible property at such time; and then (2) acquiring identical, but different, eligible property from another unrelated third party for the same amount, which in essence means a deemed sale and purchase of eligible property. Taxpayers may elect out of the delayed-bonus approach on a timely filed, original tax return.
Example 3: Assume E and F are members of a consolidated group. E transfers qualified property to F, and F subsequently deconsolidates. Under the delayed-bonus approach, F would be permitted to claim the additional first-year depreciation for the property it received from E after the date on which F leaves the group.
The 2019 proposed regulations provided a component election that allows a taxpayer to treat components of a larger self-constructed property that were acquired or self-constructed pursuant to a written binding contract after Sept. 27, 2017, as being eligible for bonus depreciation if the manufacture, construction, or production of the larger constructed property began before Sept. 28, 2017. They required that in order to make the election, the larger self-constructed property must be qualified property under Sec. 168(k)(2). However, the 2019 proposed regulations did not allow the election for property placed in service after Dec. 31, 2019.
The final regulations allow the already taxpayer-favorable component election to be made even if the larger self-constructed property is manufactured, constructed, or produced for the taxpayer by another person under a written contract that does not meet the definition of a binding contract found in the 2019 final regulations; however, the contract must be entered into before the manufacture, construction, or production of the property commences.
The final regulations also expand on the definition of qualified property under Sec. 168(k)(2) to include qualified improvement property under Sec. 168(k)(3) as in effect on the day before the date of the TCJA but determined without the acquisition-date requirement. This exception does not apply to a qualified film, television, or live theatrical production. The IRS also removed the Dec. 31, 2019, placed-in-service-date requirement, so that the date on which the larger self-constructed property must be placed in service by the taxpayer to be eligible for bonus depreciation now aligns with the placed-in-service dates found under Sec. 168(k)(6).
Example 4: Assume G begins constructing a piece of equipment before Sept. 28, 2017, for use in its trade or business. Subsequently, G acquires a motor for the equipment, a component part, on Feb. 15, 2018. The fully constructed piece of equipment is placed in service March 1, 2018. G determines that the entire piece of equipment is qualified property that would have an acquisition date before Sept. 28, 2017, even though the motor is acquired after that date. G decides to make the component election for the motor. Therefore, the motor is qualified for 100% bonus depreciation, while the rest of the equipment uses the rate provided in Sec. 168(k)(8). If G did not make the election, then the entire equipment would use the lower bonus depreciation rate.
Most partnerships and many other calendar-year companies had already filed their 2019 returns prior to the final regulations being released. These taxpayers required additional guidance to allow them to make a component election because it would ordinarily be required to be made on a timely filed tax return. Therefore, the IRS has also issued Rev. Proc. 2020-50, which provides taxpayers with procedural guidance to implement the regulations, including making a component election or election out of the delayed-bonus approach. It generally allows taxpayers to either amend their tax returns or file a Form 3115, Application for Change in Accounting Method, to take advantage of the additional benefits provided by the regulations.
Taxpayers are required to apply the final regulations for tax years beginning on or after Jan. 1, 2021. Taxpayers also have the option to apply final regulations in their entirety to tax years ending after Sept. 27, 2017, but, once applied, they must be used for all subsequent years. The final regulations are generally taxpayer-favorable, so taxpayers should assess their prior years' depreciation to determine what additional benefit there might be. Alternatively, taxpayers that have relied on the 2019 proposed regulations may continue to apply the 2019 proposed regulations to tax years ending before the first tax year that begins on or after Jan. 1, 2021, except for the partnership lookthrough rule, which has been withdrawn.
Taxpayers should carefully assess the impact of both sets of regulations to determine what changes, if any, to make for prior tax years, and the changes that may be required for the final regulations right now. If a taxpayer determines it wants to take advantage of the additional benefit, it will need to take one of the corrective actions permitted by Rev. Proc. 2020-50 in the time allowed.
Greg A. Fairbanks, J.D., LL.M., is a tax managing director with Grant Thornton LLP in Washington.
For additional information about these items, contact Mr. Fairbanks at 202-521-1503 or firstname.lastname@example.org.
Contributors are members of or associated with Grant Thornton LLP.