Claiming Bonus Depreciation for 2011

How to determine date acquired in order to qualify acquired and self-constructed assets for 100 percent bonus depreciation

On March 9, 2012, the IRS released private letter ruling 201210004 (PLR 201210004), which demonstrates how the bonus depreciation rules1 apply to acquired and self-constructed assets. This is an informative ruling for 2011 tax filers since the window of opportunity to claim 100 percent bonus depreciation generally applies to qualified property acquired after Sept. 8, 2010, and before Jan. 1, 2012, and placed in service prior to Jan. 1, 2012.2

PLR 201210004 is helpful in describing how the bonus depreciation rules apply to acquired versus self-constructed assets and the importance of the terms of the construction contract in applying such rules. In addition, it illustrates the application of the rules in instances when a component of a larger project is "acquired" by an accrual method taxpayer and eligible for the 100 bonus depreciation component election, which will be helpful for taxpayers planning on making such elections with their timely-filed (including extensions) 2011 tax returns.

Discussion

PLR 201210004 involved an accrual method taxpayer whose business included selling electricity, natural gas, capacity, emissions credits, and a series of energy-related products used to optimize the operation of an energy grid. Through a wholly-owned subsidiary, the taxpayer also owned interests in a number of coal, gas and oil-fueled electric generating plants. As part of an environmental initiative, the taxpayer hired outside contractors to perform several construction projects at three of its electric generating units. The contracted work included constructing, installing and operating scrubbers, baghouses, selective catalytic reduction systems, and an activated carbon injection system. During the course of the construction work, the taxpayer entered into numerous contracts with various vendors that supplied goods and services necessary to complete the projects. Since the projects at multiple electric generating plants were large with many moving parts, the taxpayer submitted a private letter ruling request to determine how the bonus depreciation rules would apply. Specifically, the taxpayer wanted to determine which assets were eligible for 50 percent versus 100 percent bonus depreciation, as well as whether any components were eligible for the component election.

For purposes of claiming bonus depreciation, a taxpayer "acquires" qualified property when it pays or incurs the cost of the property. Self-constructed assets are generally deemed to be acquired once construction begins. For purposes of claiming 100 percent bonus depreciation, self-constructed assets are generally acquired by a taxpayer when construction, manufacturing or production begins, i.e., when physical work of a significant nature begins (not including preliminary activities such as planning or designing, securing financing, exploring or researching). The determination of when physical work of a significant nature begins is generally a facts and circumstances test, unless the taxpayer uses the 10 percent safe harbor rule provided by the bonus depreciation regulations. If a taxpayer chooses to use this safe harbor, construction will not be deemed to begin, and therefore the assets will not be deemed to be acquired for purposes of bonus depreciation, until more than 10 percent of the costs are "incurred" under the accrual method3 or "paid" under the cash method. When property is manufactured, constructed or produced for the taxpayer by another person, this safe harbor must be satisfied by the taxpayer.

For purposes of 100 percent bonus depreciation, a limited component election is available under which a taxpayer may elect to treat any acquired or self-constructed component of a larger self-constructed property as being eligible for 100 percent bonus depreciation if the component is qualified property and is acquired or self-constructed by the taxpayer after Sept. 8, 2010, and before Jan. 1, 2012.4 The term "component" may be any part of the larger self-constructed property, including items such as installation and critical testing costs. A taxpayer may make the limited component election by attaching a statement to its timely-filed return (including extensions) for the taxable year in which the larger self-constructed property is placed in service.5

Based on the facts of PLR 201210004, the IRS held the following with respect to the two different types of construction projects at issue:

  • Construction project for which the taxpayer (i) retained complete control, (ii) made all important operational and strategic decisions, (iii) directly procured all services, materials and components, and (iv) paid for construction management services:
    • Under the safe harbor rule for determining when construction commenced, the taxpayer incurred the costs of services as the services were rendered to the taxpayer, and incurred the costs of property and components as the property and components were provided to the taxpayer (i.e., as the property and components were delivered, accepted or title passed depending on the taxpayer's method of accounting).
    • For purposes of making the limited component election, the taxpayer acquired components as they were delivered, accepted or when title passed depending on the taxpayer's method of accounting.
  • Turn-key, fixed-price construction project for which (i) the contractor was responsible for turning over the assets to the taxpayer in a ready-to-use condition, and (ii) the taxpayer made milestone payments during construction:
    • Under the safe harbor rule for determining when construction commenced, the taxpayer acquired the assets as they were provided (i.e., as delivered, accepted or title passed depending on the taxpayer's method of accounting).

This article was prepared by Steve Pashley, manager, Washington National Tax; Natalie Tucker, director, Washington National Tax and Tom Windram, partner, Washington National Tax.

1See section 168(k) and Rev. Proc. 2011-26.
2Or before Jan. 1, 2013, in the case of certain longer-lived and transportation property.
3That is, when the all events test and economic performance requirement of section 461 are met.
4Before Jan. 1, 2013, in the case of certain longer-lived and transportation property.
5Such statement should indicate that the taxpayer is making the election provided in section 3.02(2)(b) of Rev. Proc. 2011-26, and whether the taxpayer is making the election for all or some of the components described in section 3.02(2)(b) of Rev. Proc. 2011-26.