Businesses Still Await More Guidance On Bonus Depreciation

While the Internal Revenue Service recently finalized rules on the 2017 tax law's bonus depreciation provision, businesses interested in utilizing the rule are awaiting more guidance regarding business interest expensing and component election questions that remain unanswered. 

Partnerships in particular received favorable treatment in the final regulations released last month that got rid of a look-through rule for determining whether a partner had a previous interest in property and therefore would be ineligible for the 100% first-year depreciation deduction. That proposed rule would have been too administratively burdensome in terms of reporting and enforcement, the IRS said. 

But businesses interested in the bonus depreciation rule are still looking to the IRS to answer certain questions left unaddressed, specifically how the rules interact with the business interest expense rule under Internal Revenue Code Section 163(j) and how exactly businesses can retroactively elect to apply the bonus depreciation rule for components of assets. 

The IRS has promised to roll out additional guidance soon, which could help stimulate investments throughout the economy as businesses facing the effects of the novel coronavirus pandemic look for lifelines. 

"Nothing is 'normal' in the business community right now," Andrea Mouw, partner-in-charge of accounting methods and periods at Eide Bailly LLP, told Law360.

"We are seeing some interest in bonus depreciation for the purpose of going back and reclaiming some previously paid tax," she said. Alternatively, bonus depreciation "can be used as a mechanism to increase a 2020 loss." 

Section 168(k)  of the IRC provides a 100% deduction for the cost of depreciable business assets with a recovery period of 20 years or less for the first year the property is placed in service.

Under the statute, previously owned property doesn't qualify for bonus depreciation, as a means to prevent the "churning" of assets in which an asset would be sold and later repurchased to get another 100% deduction.

Notably, the IRS chose to withdraw the partnership look-through rule in the final rules. The look-through rule, proposed in September of last year, would have treated a partner as having a previous interest in property if the partner belonged to a partnership at any time the partnership owned the property.

The administrative burden of imposing that rule would have been too onerous, Timothy Powell, an official at the U.S. Department of the Treasury's Office of Tax Policy, said during a panel discussion at the American Bar Association Section of Taxation's fall meeting last month. 

"We felt that to write a rule that worked in all scenarios that got to the answer we thought was appropriate in all scenarios, was going to put a significant administrative burden on taxpayers," he said.

The agency chose not to introduce a replacement rule focused on controlling partners because the boundaries imposed by existing rules involving related party transactions were sufficient, Powell said.

Tax departments across the country exhaled a collective sigh of relief after learning the IRS chose to withdraw the rule, Sean Jackowitz, tax associate at Jones Day, told Law360. 

"It would have been a headache to administer and comply with," he said. "And the statute kind of laid out its own rules, so it was kind of strange in the first place to put out there." 

But while the IRS put the look-through issue to rest in the final regulations, it left some questions unanswered, such as the intersection of bonus depreciation with the business interest expensing rules provided under Section 163(j). The Tax Cuts and Jobs Act changed Section 163(j) to cap the deduction for net business interest expense at 30% of adjusted taxable income. 

Businesses that use floor plan financing qualify for an exception to the 30% cap on interest expense deductions, but if they make use of the exception they are ineligible to also benefit from bonus depreciation. 

In the Joint Committee on Taxation's 2018 Bluebook explanation of the TCJA, the JCT indicated that Congress intended to give businesses that use floor plan financing — lending used to acquire motor vehicles for retail sale or lease and secured by inventory — a choice of whether to make use of the Section 163(j) exception. 

In the absence of guidance to the contrary, some businesses have followed the JCT's interpretation, Jane Rohrs, managing director at Deloitte Tax LLP, told Law360. Those businesses that followed the Bluebook were disappointed to find the IRS didn't elaborate on that topic in its final bonus depreciation regulations, she said.

"There were many taxpayers who wanted the government to issue regulations that included the examples that are in the Bluebook, and the government chose not to," she said. "The question is, well, how are taxpayers going to fix that?"

Elizabeth Binder, an attorney in the IRS' Office of Chief Counsel, said during the ABA panel discussion that the agency's position on the topic differs from the JCT's. 

"We do not believe the calculation for the interest limitation under 163(j) is optional," Binder said. "It's in the statute, and we just don't read it as an optional computation." 

The IRS is working on procedural guidance that may address how businesses that followed the JCT's guide can amend their positions, Binder said.

There's also the question of how businesses can retroactively apply for bonus depreciation component elections, now that the most recent batch of final regulations allows them to do just that, Mouw said. Component elections refer to taxpayers' ability to claim bonus depreciation for composite segments of assets. 

"How can I go back and make those elections?" she said. "How does that work?"

Tracy Watkins, senior director at RSM US LLP, told Law360 the statute allows businesses to use bonus depreciation component elections for "larger self-constructed property" for which production or other activities began before Sept. 28, 2017, but the final rules do not define what the term means. 

That could work to businesses' benefit if they are given latitude to define what "larger self-constructed property" is, Watkins said. Watkins and her clients will also be watching closely to see whether the IRS retains that language when releasing its procedural guidance. 

"From a client perspective, in some ways, they are more concerned about the forthcoming procedural guidance than they were about these rules," Mouw said. 

--Additional reporting by Amy Lee Rosen. Editing by Robert Rudinger and Vincent Sherry. 

Correction: This story has been updated with the correct date by which production must begin on larger self-constructed property to qualify for bonus depreciation.

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