Proposed Bonus Depreciation Regulations Offer Little Relief to Retailers and Restaurant Owners | Practical Law

Proposed Bonus Depreciation Regulations Offer Little Relief to Retailers and Restaurant Owners | Practical Law

The IRS has issued proposed regulations implementing changes to the bonus depreciation deduction for qualified commercial property investments provided in the recent Tax Cuts and Jobs Act. Although the regulations clarify certain parts of the legislation, they do not fix an apparent error denying the full benefit of the deduction to retailers, restaurant owners, and other parties seeking to improve commercial real estate.

Proposed Bonus Depreciation Regulations Offer Little Relief to Retailers and Restaurant Owners

by Practical Law Real Estate
Published on 04 Sep 2018 • USA (National/Federal)
The IRS has issued proposed regulations implementing changes to the bonus depreciation deduction for qualified commercial property investments provided in the recent Tax Cuts and Jobs Act. Although the regulations clarify certain parts of the legislation, they do not fix an apparent error denying the full benefit of the deduction to retailers, restaurant owners, and other parties seeking to improve commercial real estate.
On August 8, 2018, the IRS published proposed regulations addressing amendments to the Internal Revenue Code (IRC) in the Tax Cuts and Jobs Act (Act) affecting the additional (bonus) depreciation deduction for certain commercial investments (Pub. L. No. 115-97 (2017)). Unfortunately, the regulations do not resolve an oversight in the Act preventing taxpayers from claiming a deduction for qualified improvement property.

Background

Section 168 of the IRC permits a bonus depreciation deduction for the purchase of qualified property in the year it is first placed in service. Generally, property must be depreciable over 20 years or less under the IRC's guidelines to qualify for bonus depreciation.
Before the Act, bonus depreciation was capped at 50 percent of the property's adjusted basis. The Act increased the deduction to 100 percent of adjusted basis for qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023.
The Act also amended Section 168 by replacing the following qualified property categories with an expanded definition of qualified improvement property:
  • Leasehold improvement property.
  • Restaurant property.
  • Retail improvement property.
Each of the eliminated categories was subject to a 15-year depreciation period and, accordingly, qualified for bonus depreciation.
In an apparent oversight, the Act did not designate qualified improvement property (in its amended form) as depreciable over 20 years or less. Therefore, under the Act, retail, restaurant, and commercial leasehold improvements that formerly qualified for bonus depreciation now:
  • Must be depreciated over the default 39-year period for commercial real property.
  • Are no longer entitled to any bonus depreciation.
For a discussion of the practical effects of this legislative error, see Legal Update, Errors in Tax Cuts and Jobs Act May Cost Retailers.

Proposed Regulations

Because the IRS likely views remediation in this case as a legislative responsibility, the proposed regulations do not resolve the bonus depreciation error. However, the regulations appear to confirm that improvements in the eliminated property categories may continue to qualify for bonus depreciation if they were placed in service after September 27, 2017, and before January 1, 2018 (the effective date of the relevant amendments).
The proposed regulations also clarify the following technical points:
  • A taxpayer may now claim bonus depreciation for used property, but only if the taxpayer or its predecessor did not have a depreciable interest in the property before acquiring it, among other requirements.
  • If a taxpayer acquires a depreciable interest in a portion of a property and later acquires another depreciable interest in the same property, the additional interest is not considered previously used by the taxpayer.
  • If a taxpayer owns a depreciable interest in a portion of a property, sells that portion, and then acquires a depreciable interest in another portion of the same property, the taxpayer is treated as having a depreciable interest in the property up to the amount of the portion owned before the sale.
Among other topics, the regulations address:
  • Consolidated groups. Although members of a consolidated group are usually treated as separate taxpayers, the group is deemed to have a depreciable interest in a property if any current or previous member owned the interest while in the group.
  • Related transactions. When there is a series of "related transactions" (for example, when a parent sells property to a child through an unrelated intermediary), the transfer is treated as occurring directly between the related parties. The IRS examines the relationship between the original seller and ultimate purchaser after the last transaction is completed.
The comment period for the proposed regulations ends on October 9, 2018.

Practical Implications

The ongoing failure to fix the bonus depreciation error discourages commercial real estate owners and tenants, particularly retail and restaurant businesses, from investing in improvements to their properties in an otherwise favorable economic climate. The IRS's proposed regulations would presumably apply to the eliminated property categories if curative Congressional action restores their qualification for bonus depreciation. In addition to monitoring legislative developments, counsel can assist property owners interested in making commercial improvements by determining whether other tax incentives, such as the federal deduction for qualified real property expenses (also modified by the Act), apply to a given project.
For a summary of the key changes made by the Act, see Legal Update, Sweeping Tax Overhaul Enacted.
For an overview of provisions in the Act affecting real estate, see Article, Tax Act Gives Cuts to CRE Owners and Limits Deductions for Homeowners.