Q1: What are the eligibility requirements for the additional first year depreciation deduction following the enactment of the Tax Cuts and Jobs Act of 2017 (“TCJA”)?
A1: The depreciable property must meet four requirements to be qualified property. These requirements are (1) the depreciable property must be of a specified type; (2) the original use of the property must commence with the taxpayer or used depreciable property must meet the requirements of section 168(k)(2)(E)(ii); (3) the depreciable property must be placed in service by the taxpayer within a specified time period or must be planted or grafted by the taxpayer before a specified date; and (4) the depreciable property must be acquired by the taxpayer after September 27, 2017. For additional information about these requirements see Proposed Treas. Reg. § 1.168(k)-2(b)) and the About Form 4562 webpage.
Q2: Because the additional first year depreciation deduction is mandatory for qualified property, is there a way to elect out of this deduction?
A2: A taxpayer may elect out of the additional first year depreciation for the taxable year the property is placed in service. If the election is made, it applies to all qualified property that is in the same class of property and placed in service by the taxpayer in the same taxable year. See Proposed Treas. Reg. § 1.168(k)-2(e)(1)(ii) for definition of class of property and the About Form 4562 webpage for additional information.
The election must be made by filing a statement with Form 4562, “Depreciation and Amortization,” by the due date, including extensions, of the Federal tax return for the taxable year in which the qualified property is placed in service by the taxpayer. See Proposed Treas. Reg. § 1.168(k)-2(e) and the About Form 4562 webpage for more information on electing out of the additional first year depreciation.
Q3: Does only new property qualify for the additional first year depreciation deduction as amended by the TCJA?
A3: No. As modified by the TCJA, there are two separate requirements – (1) original use, or (2) used property that meets certain acquisition requirements. The original use requirement will be met if the original use of the property commences with the taxpayer.
The used property requirement is met if the acquisition of the used property by the taxpayer meets the following five requirements: (a) the property was not used by the taxpayer or a predecessor at any time prior to such acquisition; (b) the property was not acquired from a related party or component member of a controlled group; (c) the taxpayer’s basis in the property is not determined in whole or in part by the seller’s or transferor’s adjusted basis in the property; (d) the taxpayer’s basis in the property is not determined under section 1014(a) or 1022, relating to property acquired from a decedent; and (e) the cost of the property does not include the basis of property determined by the reference to the basis of other property held at any time by the taxpayer. See Proposed Treas. Reg. § 1.168(k)-2(b)(3)(iii) and the About Form 4562 webpage for additional information
Q4: What is Qualified Improvement Property (QIP) and does it meet the requirements for first year depreciation deduction?
A4: The PATH Act of 2015 created a new category of real property known as QIP for purposes of the additional first year depreciation deduction. The term “qualified improvement property” means any improvement to an interior portion of a building which is nonresidential real property if such improvement is placed in service after the date such building was first placed in service by any person. However, QIP does not include any improvement for which the expenditure is attributable to: the enlargement of the building; any elevator or escalator, or the internal structural framework of the building.
The TCJA made changes to certain real property as well as modified the additional first year depreciation deduction. As modified by the TCJA, the definition of QIP is now in section 168(e)(6) instead of under section 168(k), and QIP is classified as nonresidential real property in section 168(e). As a result, QIP no longer qualifies for the additional first year depreciation deduction if the property is acquired and placed in service after December 31, 2017. However, QIP acquired and placed in service between September 28, 2017 and December 31, 2017 qualifies for the 100-percent additional first year depreciation deduction if all other requirements for such deduction are met.
To summarize, QIP acquired and placed in service after September 27, 2017 and before January 1, 2018 may be eligible for 100% bonus depreciation. QIP acquired and placed in service after December 31, 2017 is not eligible for bonus depreciation.
Q5: The new law states that the acquisition of property must be after September 27, 2017. How does this acquisition rule apply to self-constructed property?
A5: This answer discusses only one type of self-constructed property. Under the new proposed rules, if a taxpayer itself manufactures, constructs, or produces property for use in its trade or business or for its production of income, the additional first year depreciation deduction is allowed if the taxpayer begins manufacturing, constructing or producing the property after September 27, 2017, assuming all the other requirements in Q&A1 above are satisfied.
Construction is considered to begin when physical work of a significant nature begins. Physical work does not include preliminary activities such as planning, designing, securing financing, exploring, or research. The taxpayer may choose to determine when physical work of a significant nature by applying the safe harbor provided under the new proposed rules. Under this safe harbor, physical work of a significant nature will be considered to begin at the time the taxpayer incurs (if using an accrual basis method) or pays (if using the cash basis method) more than 10-percent of the total cost of the property (excluding the cost of any land and preliminary activities described above). If a taxpayer chooses the 10-percent method, the taxpayer must file an income tax return for the placed-in-service year of the property that determines when the significant work begins.
Q6: The new law for “bonus” depreciation has been expanded to include used property if it meets certain requirements. Please explain “used property” as it relates to bonus depreciation.
A6: First, bonus depreciation is another name for the additional first year depreciation deduction provided by section 168(k). Prior to enactment of the TCJA, the additional first year depreciation deduction applied only to property where the original use began with the taxpayer. The new law expands the definition of qualified property to include used depreciable property if the five requirements in Q&A3 above are satisfied and the other requirements for bonus depreciation are met.
This FAQ is not included in the Internal Revenue Bulletin, and therefore may not be relied upon as legal authority. This means that the information cannot be used to support a legal argument in a court case.