Tax Reform Muddies the Water on Bonus Depreciation

The Treasury and Internal Revenue Service (IRS), on Sept. 13, 2019, released final regulations under Internal Revenue Code section 168(k) regarding the new 100% bonus depreciation that allows businesses to fully expense qualified assets when placed in service. The final regulations provide anticipated clarity for the proposed regulations that were issued in August 2018.

Qualified Improvement Property remains ineligible for bonus depreciation

For tax years beginning after Dec. 31, 2017, the 2017 Tax Cuts and Jobs Act (TCJA) eliminated the 15-year MACRS property classifications for qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property, and replaced them with one classification: qualified improvement property (QIP). The legislative history of the 2017 Act clearly indicates that lawmakers anticipated assigning QIP a recovery period of 20 years or less to make it eligible for the new 100% bonus depreciation.

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However, the TCJA failed to amend section 168(e) to actually give QIP a recovery period of 15 years. Because of this drafting oversight, taxpayers must use a 39-year recovery period for QIP, making it ineligible for bonus depreciation. Much to commenters’ dismay, the final 168(k) regulations indicate that the Treasury and IRS declined to adopt comments to fix the “retail glitch” that prevents businesses from claiming bonus depreciation on their qualified improvement property (QIP).

While companies that have QIP cannot utilize the tax benefit of 100% bonus depreciation, they are still able to claim depreciation deductions over the life of the asset. Until the error is fixed through a legislative change, companies will need to track these assets and look for a solution that offers flexibility.

Property used to calculate Qualified Business Asset Investment may be eligible for bonus depreciation

The TCJA also introduced two new types of income subject to U.S. tax: global intangible low-taxed income (GILTI) and foreign derived intangible income (FDII). To compute these amounts, a company must first compute its qualified business asset investment (QBAI).

QBAI is the average of the taxpayer’s quarterly adjusted basis amounts in depreciable tangible property. The adjusted basis of property is determined by using the alternative depreciation system (ADS) under section 168(g) and allocating the depreciation deduction ratably to each day during the period in the tax year to which the depreciation relates.

For purposes of the daily allocation, the depreciation is determined without regard to the applicable conventions under section 168(d), such as half-year or mid-month. This means that in the placed in service and disposal years, the depreciation deduction allowed for those taxable years is allocated from the day the property is placed in service and through the date of disposal, respectively. This effectively results in a new depreciation calculation and added complexity.

The Treasury and IRS recognized that there was some uncertainty about whether using ADS to determine QBAI would cause otherwise qualified property to be ineligible for the bonus depreciation deduction. While generally property that is required to be depreciated under ADS is not eligible for bonus depreciation, the final regulations under section 168(k) clarify that the ADS requirement does not cause a property to be ineligible for bonus depreciation under the GILTI and FDII provisions. On the other hand, property that is required to be depreciated under ADS because it is used predominantly outside the United States remains ineligible for bonus depreciation.

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The Treasury and the IRS anticipated that most taxpayers would have come to this conclusion, absent the final regulations. However, this explicit clarification gives certainty to taxpayers that property used for determining QBAI might qualify for bonus depreciation despite interactions with other Code provisions.

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