Bonus Depreciation Update
Panel discussions including Treasury and IRS officials at the American Bar Association Tax Section mid-year meeting on Jan. 21, 2011 addressed many of the issues surrounding the recent extension of bonus depreciation and the temporary 100 percent bonus depreciation deduction. These depreciation provisions were enacted as part of the Small Business Jobs Act of 2010 (SBJA) and the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (Tax Relief Act). Treasury and IRS officials should be issuing guidance within the next month to resolve the issues discussed below.
Fiscal year taxpayers
The SBJA extended the 50 percent bonus depreciation for one year, i.e., for eligible property placed in service before Jan. 1, 2011 (or Jan. 1, 2012 for certain longer-lived or transportation property). See Small Business Jobs Act of 2010 Signed by President Obama. Bonus depreciation is mandatory unless the taxpayer makes a valid election to opt out under section 168(k)(2)(D)(iii). Accordingly, taxpayers with a fiscal year beginning in calendar year 2009 and ending in calendar year 2010 that do not make a valid election out of bonus depreciation must claim the bonus depreciation on eligible property placed in service after Dec. 31, 2009 and before its applicable year-end. As a result, a fiscal-year taxpayer that previously filed its 2009 tax return without claiming bonus depreciation for eligible property placed in service after Dec. 31, 2009, and without affirmatively electing out, should consider filing a method change request with its 2010 tax return, or a superseding or amended return depending on whether the extended due date for the 2009 return has passed, in order to properly claim bonus depreciation.
Treasury and the IRS are aware of the administrative issues faced by fiscal year taxpayers resulting from the late extension of the 50 percent bonus depreciation by the SBJA, and are considering transition rules for fiscal year taxpayers as part of guidance under section 168(k) to be issued next month.
100 percent bonus depreciation
One of the main business incentives in the Tax Relief Act is the provision of 100 percent bonus depreciation. See Obama Tax Compromise Approved by Congress. The 100 percent bonus depreciation is available for qualified property placed in service after Sept. 8, 2010 and before Jan. 1, 2012, with an extended placed-in-service date running until Jan. 1, 2013 for certain longer-lived and transportation property (LLTP). The new provisions of section 168(k)(5) raise the following issues that should be addressed by the upcoming guidance to be issued by Treasury and the IRS.
Ability to elect into 50 percent bonus depreciation
Section 168(k)(2)(D)(iii) currently only permits an election out of bonus depreciation on a class-by-class basis, as follows:
If a taxpayer makes an election under this clause with respect to any class of property for any taxable year, this subsection shall not apply to all property in such class placed in service during such taxable year.
Furthermore, the plain language of new section 168(k)(5) as currently drafted, provides no statutory support for electing 50 percent instead of 100 percent bonus depreciation. Specifically, section 168(k)(5) states:
In the case of qualified property acquired by the taxpayer . . . after September 8, 2010, and before January 1, 2012, and which is placed in service by the taxpayer before January 1, 2012 (January 1, 2013, in the case of property described in subparagraph (2)(B) or (2)(C)[certain LLTP and aircraft]), paragraph (1)(A)[the depreciation deduction] shall be applied by substituting “100 percent” for “50 percent”. (Emphasis added.)
As a result, taxpayers do not currently have the ability to claim 50 percent bonus depreciation instead of 100 percent bonus depreciation. Treasury and the IRS are aware of this issue.
Interplay of written binding contract and acquisition date rules
Qualified property acquired under a written binding contract entered into after Dec. 31, 2007, which property is placed in service within the applicable dates noted above—after Sept. 8, 2010 and before Jan. 1, 2012, before Jan. 1, 2013 for certain LLTP—is also eligible for 100 percent bonus depreciation, assuming all other requirements of section 168(k) are met. Specifically, the Joint Committee on Taxation’s Technical Explanation of the Revenue Provisions Contained in the “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010” Scheduled for Consideration by the United States Senate (JCX-55-10), issued on Dec. 10, 2010, states:
Rules similar to those in section 168(k)(2)(A)(ii) and (iii), which provide that qualified property does not include property acquired pursuant to a written binding contract that was in effect prior to January 1, 2008, apply for purposes of determining whether property is eligible for the temporary 100 percent additional first-year depreciation deduction. Thus, under the provision, property acquired pursuant to a written binding contract entered into after December 31, 2007 is qualified property for purposes of the 100 percent additional first-year depreciation deduction assuming all other requirements of section 168(k)(2) are met.
While the new binding contract rule is very liberal in determining eligibility, the acquisition date is still important. That is, while a binding contract for acquiring the property may have been entered into on or after Jan. 1, 2008, the qualifying property must actually be acquired and placed in service after Sept. 8, 2010 and before Jan. 1, 2012 (Jan. 1, 2013 for certain LLTP) in order to be eligible for 100 percent bonus depreciation. For example, new qualified property acquired in Aug. 2010 pursuant to a written binding contract entered into in July 2010, but that is placed in service in Oct. 2010, would not be eligible for 100 percent bonus depreciation because the property was acquired prior to Sept. 9, 2010. However, the property would be eligible for 50 percent bonus depreciation.
With respect to self-constructed assets, the issue becomes when such property is deemed to be acquired. Current section 168(k)(2)(E)(i) allows taxpayers that are self constructing assets to get past the written binding contract rules, but not the acquisition date rules. Specifically, section 168(k)(2)(E)(i) states:
In the case of a taxpayer manufacturing, constructing, or producing property for the taxpayer's own use, the requirements of clause (iii) of subparagraph (A) shall be treated as met if the taxpayer begins manufacturing, constructing, or producing the property after December 31, 2007, and before January 1, 2013.
Thus, self-constructed assets are generally deemed to be acquired once construction begins. In order to be eligible for 100 percent bonus depreciation, the property still must be acquired after Sept. 8, 2010. There is a safe harbor for purposes of the bonus depreciation provisions under which construction will not be deemed to begin and, therefore, the assets will not be deemed to be acquired until more than 10 percent of the costs of such property are incurred. See Treas. Reg. § 1.168(k)-1(b)(4)(iii)(B)(2). Limitations are also provided for the components of self-constructed assets. See Treas. Reg. § 1.168(k)-1(b)(4)(iii)(C). Despite these existing provisions in the bonus depreciation regulations, many questions remain regarding the interplay of the acquisition date of self-constructed assets and the written binding contract rules. Treasury and the IRS are aware of the issues and will provide clarity in the upcoming guidance.
Longer-lived and transportation property
Under section 168(k), taxpayers have an additional year to place in service certain property with long production periods. The extension of the placed-in-service date applies to certain property with a recovery period of 10 years or more, or to transportation property that has an estimated production period of greater than one year and a cost in excess of $1 million (i.e., the property must meet the requirements of section 263A(f)(1)(B)(iii)). Notwithstanding the extended placed-in-service date, bonus depreciation is limited to costs incurred prior to the applicable date. Costs incurred during 2011 are generally eligible for 100 percent bonus depreciation; costs incurred during 2012 are generally eligible for 50 percent bonus depreciation. In other words, section 168(k)(2)(B) is not an extension of the applicable bonus depreciation provision, just the placed-in-service date. It is anticipated that a technical correction will be made to make this clear in the context of the 100 percent bonus depreciation deduction under section 168(k)(5).
Interplay of bonus depreciation and section 1603 grants
The ordering rules for bonus depreciation and for reducing the basis of assets for grants under the “grant in lieu of tax credits for specified energy property program” (section 1603 of the American Recovery and Reinvestment Act of 2009 – see January 2011 McGladrey Tax Digest: Energy Grant Program Extended), have been clarified. A staff member of the Joint Committee on Taxation (JCT) has stated that basis should be reduced first for the section 1603 grant provisions, and then reduced for the applicable bonus depreciation deduction.
Qualified leasehold improvement property that is also qualified restaurant or retail improvement property
At issue is whether assets that qualify as both (1) qualified leasehold improvement property and either (2) qualified restaurant property or qualified retail improvement property qualify for bonus depreciation. Officials from Treasury and JCT confirmed that, if property constitutes qualified leasehold improvement property and either qualified restaurant property or qualified retail improvement property, it is still eligible for bonus depreciation (i.e., it is treated as qualified leasehold improvement property). This clarification is also currently in HR 4169, a technical corrections bill that was issued in the House of Representatives in Dec. 2009.
Round 2 extension property under section 168(k)(4)
The Act also extends the section 168(k)(4) election allowing corporations to accelerate pre-2006 AMT credits, but not research credits, in lieu of bonus depreciation for tax years 2011 and 2012. In doing so, the Act permits taxpayers to reconsider whether prior section 168(k)(4) elections apply to round 2 extension property. Round 2 extension property is defined as:
property that is eligible qualified property solely because it meets the requirements under the extension of the additional first-year depreciation deduction for certain property placed in service after December 31, 2010.
In its explanation of this extension, the JCT clarifies that:
[a]n election under new section 168(k)(4)(I) with respect to round 2 extension property is binding for any property that is eligible qualified property solely by reason of the amendments made by section 401(a) of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (and the application of such extension to this paragraph pursuant to the amendment made by section 401(c)(1) of such Act), even if such property is placed in service in 2012.
Accordingly, a corporation that makes a section 168(k)(4) election will generally be required to increase its AMT credit limitation by the bonus depreciation amount with respect to certain property placed in service after Dec. 31, 2010 and before Jan. 1, 2013 (Jan. 1, 2014 in the case of certain LLTP). This means that a section 168(k)(4) election would generally apply to all of the corporation’s assets for all of 2011 and 2012. Representatives from Treasury highlighted the fact that an election out of bonus depreciation either entirely, or on a class-by-class basis, under section 168(k)(2) is an annual election. Thus, under the statute, if a corporation wants to make a section 168(k)(4) election for 2011 only, it could not do so without also electing out of bonus depreciation entirely for all of its otherwise eligible assets placed in service in 2012.
In summary, be on the lookout next month for additional guidance on the recently expanded bonus depreciation provisions. Once issued, another alert will be forthcoming.
Natalie Tucker, Jacksonville, FL 904-680-7209
January 27, 2011
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