In 2017 as part of the Tax Cuts and Jobs Act (TCJA), Congress made major changes to the bonus depreciation rules affecting partnerships. For open tax years, partners should assess carefully whether they want to adopt the final regulations or the 2019 proposed regulations based on their tax circumstances.
Bonus depreciation allows businesses to take a 100% deduction during the tax year the depreciable business property is first put into service if the recovery period is twenty (20) years or less. This means that if twenty (20) years or less is allowed to depreciate qualified business property, when businesses file their tax returns, they can elect to take all of the allowed depreciation in the year the qualified depreciable business property was first put into service (purchased).
In its final guidance, the IRS allows previously owned property that was disposed, repurchased, and placed back in service to be depreciated again if:
(a) there is at least ninety (90) days between the disposition and being replaced back into service; and
(b) the purchase and repurchase did not occur during the same tax year.
Internal Revenue Code Section 168(k).
Example. ABC Company purchased business equipment that a few months later it determined it did not need and sold to XYZ Company. Six months after the sale, ABC Company realized it did need the equipment and worked out a deal to buy it back from XYZ Company.
If the companies and equipment met all the necessary requirements, both would be able to claim 100% depreciation for the same business equipment. If ABC Company purchased it back in the same tax year even though it was over ninety (90) days later, they would not be able to claim depreciation for the same property twice. However, under the final guidance issued by the IRS, if the repurchase occurred in a different tax year for ABC Company, it would be able to claim depreciation for the same business equipment on their next tax return. Therefore, claiming the depreciation on the same qualified business equipment two years in a row.
In its final guidance issued last year: “[t]he Treasury Department and the IRS believe that property that is placed in service, disposed of, and reacquired in the same taxable year is more likely to be part of a predetermined churning plan.” They believe by disallowing repurchased depreciable business property to be claimed in the same tax year as the purchase will nearly eliminate misuse of this tax law.
The final regulations withdraw the partnership look-through rule. This was a drastic change. Under the 2019 regulations as proposed, partners would have been considered to have a depreciable interest in property that belonged to the partnership based on the share of depreciation allocated to the partner on that property for the past six calendar years, including the current one. This rule, as written, would have caused an administrative and compliance nightmare both for the partnership, partner, and the IRS. Furthermore, it would have limited bonus depreciation in many transactions that result in minority increases for minority partners. This is because it would have required the tracking of look-through ownership for the minority partners as well.
In the final regulations, the look-through rule has been rescinded. Now, a partner will not have a prior depreciable interest in the partnership property solely because they became a partner in the partnership. The IRS did not replace the rule as it feels other sections already address these issues, specifically, Section 179(d)(2) - related-party rules and the other transactional rules. The IRS believes by eliminating the look-through rule that the other rules will prevent abuse while limiting the administrative burden on both the IRS and partners.
Another great thing about the final regulations is they clarify Section 743(b) adjustments. Now, an election out of bonus depreciation can be made by the partnership for each partner’s basis adjustment for each class of property. Therefore, each partner with this type of adjustment can decide to elect out of bonus depreciation based on their own tax circumstances without any consequences to the other partners.
Because the partnership look-through rule was rescinded from the 2019 proposed rules in its entirety, it should not be applied for 2019 and following years.
The final regulations issued by the IRS address many questions previously left unanswered when assets are transferred. They determine that the transferee tests its relationship with the transferor either (a) immediately before the first transfer of property or (b) when the transferee accepts the property. If the transferee is related to either the current transferor or the original transferor, then the transferee is not eligible to take bonus depreciation on the otherwise qualified property. Furthermore, if the party no longer exists when the transfer is complete, it is deemed to exist by the IRS in regard to establishing relatedness for bonus depreciation in this transaction. This means even if a business dissolves it does not pave the way for the transferee to claim bonus depreciation if the parties were related.
The law provides a list of covered relationships, including spouses, ancestors, and lineal descendants and certain relationships involving trusts, partnerships, corporations, and charitable organizations. Internal Revenue Code Sections 179(d)(2)(A) and 267.
Example. John transfers qualified property to Mary. Mary then transfers the same property to Robert. Finally, Robert transfers the property to Susan.
In this situation, Mary would need to test her relatedness with John. Robert would need to test his relatedness to both Mary and John. Then Susan would have to test her relatedness to Robert and John. Every transferee needs to test their relatedness to John because he was the original transferor and each immediate transferor that transferred them the property.
Even if John dissolved his business before Robert transferred the property to Susan, Susan would still need to test her relatedness to John. This is because the IRS for the test of relatedness considers the parties in existence in determining whether the transferee qualifies for bonus depreciation on the qualified property.
The final regulations became effective for tax years beginning on or after January 1, 2021. Also, the IRS gave partners the option of applying the final regulations to tax years ending after September 27, 2017. However, once applied, the final regulations must be used for all subsequent tax years. No picking and choosing. Usually, the final regulations are more taxpayer friendly both administratively and tax-wise. This means it may well be worth your time to assess and take corrective action regarding the depreciation on your prior years’ tax returns.
Partners relying on the 2019 proposed regulations (except for the look-through rule because it was withdrawn in its entirety) may continue to apply them to tax years up until the first tax year that begins on or after January 1, 2021.
When making transfers of qualified business property, it is important to consider and plan for bonus depreciation. With the options available, it is important if your partnership has qualified depreciable property that you seek the guidance of tax professionals. Whether you choose to implement the final regulations issued in 2020 to previous tax years or not depends on your specific circumstances. Don’t leave money on the IRS floor.
The transferee will need to pass the relatedness test not only with the immediate transferor but with the original transferor as well, even if they dissolved their business. Also, the IRS in the final regulations, rescinded the look-through rule for partnerships, making it easier for partners and the IRS to ensure compliance. If you are considering making a transfer of qualified property or trying to determine to take corrective action on your past tax returns, schedule an appointment today with the accounting and tax preparation professionals at Gudorf Tax Group. Located in Dayton, Ohio, they will ensure you have the information to weigh your options carefully and choose the best course of action for your business.