New final and proposed regulations explain how to determine the acquisition date of constructed property that can qualify for 100% bonus depreciation (Reg. §1.168(k)-2(b)(5); Proposed Reg. §1.168(k)-2(c)). Property constructed by or for a taxpayer qualifies for 100% bonus depreciation only if it is:
- acquired after September 27, 2017, and
- placed in service before 2023 (or before 2024 for “long production property”).
Significantly, the rules:
- treat property constructed for a taxpayer under a binding contract as self-constructed, and
- allow taxpayers to claim 100% bonus on components acquired after September 27, 2017, even if the larger constructed property is acquired before September 28, 2017.
Property Constructed by the Taxpayer
Property constructed by a taxpayer for its own use is acquired on the date that construction begins. Construction generally begins on the date that physical work of a significant nature begins. This is a facts and circumstances test.
Preliminary activities are not taken into account. Examples of preliminary activities include:
- Planning or designing
- Securing financing
- Exploring or researching
- Clearing a site
- Test drilling to determine soil condition
- Excavation to change the contour of land
It appears that under the “facts and circumstances” test, construction work on a component built off-site may need to be taken into account in determining whether physical work of a significant nature has begun on the larger structure. The IRS regulations are silent on this point except to provide the obvious example that construction of a retail motor fuels outlet assembled from modular units manufactured off site begins when physical work of a significant nature begins off-site (Reg. §1.168(k)-2(b)(5)(iv)(B)).
10% Safe Harbor
Under an elective safe harbor, construction begins on the date that more than 10% of the total cost of construction is paid for by a cash basis taxpayer or incurred by an accrual basis taxpayer (Reg. §1.168(k)-2(b)(5)(iv)(B)). The cost of preliminary activities land does not count toward the 10% safe harbor.
EXAMPLE: ABC, an accrual basis steel manufacturer, enters into a binding contract in October 2016 for the construction of a turbine that will be part of a self-constructed power generation plant. ABC incurs the cost for the turbine when it is delivered in August 2017. ABC is treated as acquiring the plant before September 28, 2017, if the safe harbor is elected and the cost of the turbine plus any other costs incurred toward construction before September 28, 2017 is more than 10% of the total cost of the plant (Proposed Reg. §1.168(k)-2(c)(7)(ii)), Example 2).
Property Constructed for the Taxpayer
Property constructed for a taxpayer by a third party is almost always constructed under a binding written contract. Regulations originally proposed by the IRS provided that the 100% bonus rate did not apply to third-party construction if a binding written contract was entered into before September 28, 2017.
This rule, however, was abandoned in final regulations. Instead, property constructed for a taxpayer under a binding written contract entered into before the beginning of construction is considered self-constructed (Reg. §1.168(k)-2(b)(5)(ii)(A)).
This means that the acquisition date of third-party construction is also determined by reference to the date construction begins under the significant physical activity test or under the 10% safe harbor. Both of these tests significantly delay the acquisition date beyond the contract date, making it easier to qualify for 100% bonus depreciation.
COMMENT: The 10% safe harbor election is especially useful in delaying the acquisition date for an accrual basis taxpayer. The cost of property constructed for a taxpayer is generally not incurred until the property is delivered to the taxpayer upon completion of the project in the case of a turnkey contract (IRS Letter Ruling 201210004, November 22, 2011). Many construction contracts are not turnkey but rather “design-bid-build” method contracts. Depending upon the terms of the contract, amounts can be incurred in stages (Field Attorney Advice 2014020F, January 16, 2014).
Special Rules for Components of Self-Constructed Property
The cost of an “acquired” component of a self-constructed property (including property constructed for the taxpayer under a contract and considered self-constructed) does not qualify for the 100% bonus depreciation rate if it is acquired under a written binding contract entered into before September 28, 2017 (Reg. §1.168(k)-2(b)(5)(iv)(C)(1)).
Similarly, a “self-constructed” component considered acquired before September 28, 2017 under the significant physical work test or 10% safe harbor does not qualify for bonus depreciation at the 100 percent rate (Reg. §1.168(k)-2(b)(5)(iv)(C)(2)).
For example, the turbine constructed for the taxpayer in the preceding example does not qualify for 100 percent bonus depreciation because it was acquired before September 28, 2017, under both the physical work of a significant nature and 10% safe harbors. The turbine is considered self-constructed because it was acquired under a written binding contract entered into before construction began.
This exclusion for acquired and self-constructed components considered acquired before September 28, 2017, applies even if the larger self-constructed property is considered acquired after September 27, 2017.
Election for Components Acquired After September 27, 2017
If the larger property is acquired before September 28, 2017, a taxpayer may elect 100% bonus depreciation on components of the property that are acquired after September 27, 2017. A taxpayer makes the election by attaching a statement to the income tax return in the year the larger property is placed in service. If the election does not apply to all qualifying components acquired after September 27, 2017, the statement must identify the components that are covered by the election (Proposed Reg. §1.168(k)-2(c)).
The original proposed regulations denied 100% bonus depreciation on all of the components of a larger property acquired before September 28, 2017, regardless of the acquisition date of the components. Consequently, no portion of the cost of the larger property could qualify for the 100% rate.
Many comment letters asked the IRS to change this rule and create an exception similar to the one previously provided in Rev. Rul. 2011-26 for the 100% bonus rate that applied to property acquired after September 8, 2010, and before January 1, 2012. The IRS agreed to these requests.
For additional information on the acquisition date rules for constructed property see the CCH Answer Connect Topic Pages entitled:
By Ray G. Suelzer, J.D., LL.M.