Manufacturers to Benefit from Proposed Regulations on Bonus Depreciation
One of the overarching objectives of tax reform was to bring business, especially manufacturing, back within the United States’ borders. To help accomplish this goal, tax rates were reduced to compete with those of other advanced economies, thresholds were increased to remove burdens from small and mid-sized companies, and, critically, the opportunity to fully expense depreciable assets when purchased was granted.
The U.S. Treasury Department recently released proposed regulations to confirm the ability to expense qualified assets in the year that they are placed in service. This benefit is known as the 100 percent bonus depreciation deduction, and it could be very lucrative for your manufacturing company.
Property that qualifies for 100 percent bonus depreciation
To claim the 100 percent bonus depreciation deduction in the year that the qualified property was placed in service, property must:
- Qualify for modified accelerated cost recovery system (MACRS) depreciation,
- Have a recovery period of 20 years or less,
- Be purchased from an unrelated party, and
- Be acquired and placed in service after September 27, 2017, and before January 1, 2023.
Property is not treated as acquired after September 27, 2017, if a written, binding contract to purchase that property was entered into beforehand. For purposes of the proposed regulations, if you enter into a written contract to purchase a piece of equipment, and the contract states the delivery date, installation date, closing date, or other similar date, the date that the contract was entered into will be considered the acquisition date.
For example, if ABC Manufacturing Company signs a contract to purchase a computer numerical control (CNC) machine on September 1, 2017, and the machine is delivered on October 1, 2017, the purchase will not qualify for 100 percent bonus depreciation because the contract to purchase the machine was entered into before September 27, 2017. Although the machine doesn’t qualify for 100 percent bonus depreciation, it may still qualify for 50 percent bonus depreciation or Section 179 depreciation under pre-tax-reform laws.
Property that meets the above guidelines qualifies for 100 percent bonus depreciation no matter its condition when purchased. Under pre-tax-reform laws, only new property qualified for bonus depreciation in the year in which it was acquired or placed in service. The proposed regulations allow for all property, new or used, to be expensed in the year of purchase. This includes property acquired via a Section 338 transaction, which is a stock purchase treated as an asset purchase for tax purposes.
Property that doesn’t qualify for 100 percent bonus depreciation
Manufacturing property that doesn’t meet the above guidelines is not eligible for 100 percent bonus depreciation. This includes qualified:
- Improvement property formerly known as qualified leasehold improvement property
- Restaurant property
- Retail improvement property
The most common qualified improvement property is when improvements are made to the interior portion of a leased building. These improvements are specifically excluded in the proposed regulations and don’t qualify for 100 percent bonus depreciation or a 15-year recovery period, if placed in service after December 31, 2017.
However, qualified improvement property that was not placed in service, or for which a contract wasn’t entered into before September 27, 2017, and was placed in service prior to December 31, 2017, does qualify for 100 percent bonus depreciation.
If you don’t want or need to take advantage of 100 percent bonus depreciation, you can make an election on your 2017 tax return to claim 50 percent bonus depreciation rather than 100 percent bonus depreciation. This election must be made on all property placed in service during 2017, and 50 percent bonus depreciation can only be claimed on new property.
If you make the election, you still have the option to expense used property under Section 179, as long as:
- The total acquisition cost doesn’t exceed $2.5 million (2018),
- The total Section 179 expense doesn’t exceed $1 million (2018), and
- The Section 179 expense doesn’t create a taxable loss or exceed qualified business income.
The election to claim 50 percent bonus depreciation is only available for the 2017 tax year.
Self-constructed property may qualify for 100 percent bonus depreciation
If you build or construct your own assets, you may also be able to take advantage of the proposed 100 percent bonus depreciation deduction. Generally, if less than 10 percent of the overall cost of the asset was incurred before September 27, 2017, the costs can be ignored when determining the assets acquired or placed-in-service date. Therefore, if you begin building an asset on September 1, 2017, and had incurred less than 10 percent of the costs to complete construction of the asset on September 27, 2017, then the costs can be ignored and the asset will be deemed to be placed in service after September 27, 2017, and qualify for 100 percent bonus depreciation. For property placed in service prior to September 27, 2017, if larger components are added after that date, they may qualify separately for 100 percent bonus depreciation.
For example, ABC Manufacturer constructs its own conveyer system to move products throughout the manufacturing plant. The total cost of the system is $50,000, and the project started on September 15, 2017. Through September 27, 2017, ABC incurred $4,000 in costs, and the project was subsequently completed on October 15, 2017. Since ABC incurred less than 10 percent of the projected total cost prior to September 27, 2017, the entire system is considered to be placed in service after that date and qualifies for 100 percent bonus depreciation.
Qualifying partnership property may qualify for 100 percent bonus depreciation
In the partnership arena, Section 743(b) allows for a step-up in the basis of the partnership’s assets upon a sale or exchange of partnership interest. A Section 743(b) step-up might occur when a business owner sells his or her interest in a partnership as part of a succession plan. If the partnership makes a Section 754 election simultaneously with the exchange, the stepped-up basis of the underlying partnership assets is capitalized and depreciated by the purchasing partner. Under the proposed regulations, the newly created 743(b) assets qualify for 100 percent bonus depreciation as long as they meet the criteria outlined above. This includes all Section 743(b) elections that take place between September 27, 2017, and December 31, 2022.
100 percent bonus depreciation will phase out by 2027
The proposed regulations that allow for 100 percent bonus depreciation are for property placed in service between September 27, 2017, and December 31, 2022. Qualified manufacturing property placed in service after 2022 will be subject to the following reduced rates:
- • 2023 — 80 percent bonus depreciation.
- 2024 — 60 percent bonus depreciation.
- 2025 — 40 percent bonus depreciation.
- 2026 — 20 percent bonus depreciation.
The proposed regulations are slated to sunset on January 1, 2027, and no bonus depreciation will be allowed on property subsequently placed in service.
How we can help
Determining if an asset qualifies for 100 percent bonus depreciation directly impacts a manufacturer’s bottom line. The tax savings could result in additional funds to reinvest into the business or provide additional benefits to employees or owners. CLA’s manufacturing industry professionals and tax and fixed asset specialists are here to assist you in making these critical decisions.