Additional first-year depreciation rules have been released by the IRS to clear up issues relating to the increased deduction and the expansion of qualified property, including some classes of used property. The new final regulations also address rules not covered by the 2019 regulations, such as:
- the five-year safe harbor
- de minimis use
- consolidated groups
- components acquired or self-constructed after September 27, 2017, for larger self-constructed property for which manufacture, construction, or production began before September 28, 2017
- the application of the mid-quarter convention
- changes to the definitions for qualified improvement property, predecessor, and class of property
Qualified Improvement Property
The CARES Act added qualified improvement property (QIP) to the type of property qualified for bonus depreciation, applying it to leasehold and other improvements to existing buildings placed in service after December 31, 2017. QIP is defined as “any improvement made by the taxpayer to an interior portion of nonresidential real property if such improvement is placed in service after the building was first placed in service.”
The final regulations amplify the “made by the taxpayer” requirement by explaining that an improvement is considered 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. In contrast, if a taxpayer acquires nonresidential real property in a taxable transaction and the property includes an improvement previously placed in service by the seller, the improvement is not made by the taxpayer.
Used Property and 5-Year Safe Harbor
To qualify for additional first-year depreciation, a used asset cannot have been previously used by the taxpayer or a predecessor of the taxpayer, and the taxpayer or predecessor cannot have had a depreciable interest in the used property. This rule applies whether or not the taxpayer or the predecessor claimed depreciation deductions for the property. To determine if the taxpayer or a predecessor had a depreciable interest in the property at any time prior to the acquisition, the previous regulations only looked at the five calendar years immediately prior to the taxpayer’s current placed-in-service year, the “five-year safe harbor.”
The new final regulations clarify that the five calendar years immediately prior to the current calendar year in which the property is placed in service, and the portion of the current calendar year before the placed-in-service date of the property, are taken into account to determine if the taxpayer or a predecessor had a depreciable interest in the property at any time prior to acquisition. The taxpayer and predecessor are subject to a separate lookback period. Also, if the taxpayer or a predecessor, or both, have not been in existence during the entire lookback period, then only the portion of the lookback period during which they have been in existence is taken into account to determine if the taxpayer or the predecessor had a depreciable interest in the property.
De Minimis Rule
When the taxpayer disposes of property to an unrelated party within 90 calendar days after the taxpayer originally placed a property in service, the prior depreciable interest rules do not apply. This de minimis rule also does not apply if the taxpayer reacquires and again places in service the property during the same taxable year the taxpayer disposed of the property. The IRS offers several examples showing how this rule is applied. Here is one of them:
The taxpayer places the property in service in Year 1, disposes of that property to an unrelated party in Year 1 within 90 calendar days of the original placed-in-service date, and then reacquires and again places the property in service later in Year 1 and does not dispose of the property again in Year 1. Additional first-year depreciation is allowable for the property when it is placed in service again in Year 1 and is not disposed of again in Year 1 if the property is originally acquired by the taxpayer after September 27, 2017.
Larger, Self-Constructed Property
The final rules expand the type of larger self-constructed property that is eligible for the component election. Larger self-constructed property now includes property that is manufactured, constructed or produced for the taxpayer by another person under a written contract that does not have to be binding if it is entered into prior to the manufacture, construction or production of the property. The rules also address large constructed property requirements as in effect before and after the TCJA amendments to the bonus depreciation rules.
Taxpayers may choose to apply these final regulations to depreciable property acquired and placed in service after September 27, 2017, by the taxpayer during a taxable year ending on or after September 28, 2017, provided the taxpayer consistently applies all rules in the final regulations. Alternatively, taxpayers may rely on the previously proposed 2019 regulations.
If you have questions about bonus depreciation, please reach out to your Frazier & Deeter tax advisor.