Night at the Roxbury: TCJA Changes to Section 168(k); Open the door to the full expensing club for some, leaving others out in the cold.

• Author: McElroy, Ellen
• Position: Part 4 - Special Section on the Tax Cuts and Jobs Act

Since 2001, Section 168(k) of the Internal Revenue Code has offered companies accelerated recovery for the costs of capital assets through "bonus depreciation." Over the years, bonus depreciation has been regularly modified, changing both the amount of bonus depreciation as well as its application. Once again, as part of RL. 115-97 (commonly referred to as the Tax Cuts and Jobs Act, or TCJA), the bonus depreciation provisions have been modified. Immediately following the TCJA's enactment, the headline for Section 168(k) was that it offered taxpayers a bonanza, including an expanded amount of, and scope of, bonus depreciation. Although the statute does expand both amount and scope, what has become apparent is that some companies (notably capital-intensive businesses and M&A purchasers) may benefit significantly from the new bonus, whereas other businesses (for example, companies in a loss position, certain real estate entities, utilities, and companies with qualified improvement property) are finding that the bonus depreciation provisions may not offer any real bonus. Because the full expensing club does not benefit everyone, it is critical that companies fully understand the provision to determine the value of seeking entrance... and whether to do so at all.

Background

As part of the TCJA, Section 168(k) now allows full expensing (i.e., a 100% depreciation deduction) for qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023. (1) The bonus depreciation rate decreases by twenty percent each calendar year until the provision expires in 2027. (2) "Qualified property" includes Modified Accelerated Recovery System (MACRS) property with a recovery period of twenty years or less; certain computer software; water utility property; certain qualified film, television, or theater productions; and specified plant property. (3) Importantly, qualified property includes such property when the original use of the property begins with the taxpayer or the acquisition of the property meets the requirements of Section 168(k)(2)(E)(ii). (4)

Unfortunately, due to a drafting error, qualified improvement property (QIP) was inadvertently removed from the definition of qualified property. QIP includes interior improvements to existing nonresidential real property, and, although the Conference Report accompanying the TCJA makes clear the intended treatment and recovery period for QIP, such property was eliminated from qualified property due to an oversight that failed to provide QIP with a MACRS recovery period of twenty years or less. In addition, to reflect the requirements of Section 163(j), also excluded from qualified property is property used in public regulated utilities and companies with floor plan financing.

Irrespective of the QIP quagmire, compared to prior law, the TCJA did expand Section 168(k) in several important ways: 1) it increased the amount of bonus depreciation from fifty percent to 100 percent; 2) it expanded the scope of qualifying property to include film, television, and theater productions; and 3) it allowed certain used property to qualify for full expensing. (5) At the same time, the TCJA narrowed the scope of bonus depreciation, making it unavailable to 1) certain utilities; 2) companies with floor plan financing; and 3) companies with QIP (e.g., companies refreshing or updating facilities such as restaurants, retailers, and companies making improvements to plants or facilities).

On August 3, 2018, proposed regulations implementing Section 168(k) were released, (6) and although the proposed regulations address a number of issues created by these amendments, a number of open items remain.

"In Da Club": Which Companies Benefit From the New Bonus Depreciation Provisions?

Not unlike the patrons enjoying bottle service in the club's VIP section, the companies that benefit from bonus depreciation seem pretty obvious. With the increase in bonus depreciation from fifty percent to 100 percent, the beneficiaries are generally taxpayers acquiring capital assets. Purchasers acquiring used property may also benefit. The proposed regulations clarify which used property is eligible for bonus depreciation and the related effect of the used property rules on stock sales that are treated as asset sales under Section 338 or Section 336(e) and on partnership basis adjustments under Section 743. These nuances should be considered to ensure that no foot fault occurs that results in a company being barred from the full-expensing club and left out in the cold.

Prior Property...