Trade Group Raises 6 Issues With Bonus Depreciation Regs

October 8, 2018

CC:PA:LPD:PR (REG-104397-18)
Room 5203
Internal Revenue Service
P.O. Box 7604
Ben Franklin Station
Washington, DC 20044

To Whom It May Concern:

I want to thank you and the tax professionals at Treasury for the enormous work that resulted in H.R. 1, The Tax Cuts and Jobs Act of 2017 (“TCJA”), being enacted into law. This singular achievement was critically important to the oil and natural gas industry and is already fostering US economic growth. As your agency's efforts turn to implementing the legislation law through guidance and regulation, there is an opportunity to develop rules that clarify the transitions and bridge the old and new law, as well as define the new law in a way that meets the objectives intended by Congress.

With respect to the proposed regulations, “Additional First Year Depreciation Deduction” API and its member companies have highlighted several issues which we believe the proposed regulations did not address or could address differently. Two issues concern the application of the proposed regulations to previously used property and its owners. The proposed regulations should not be overly broad or include requirements not imposed by the TCJA. Three issues concern rules for the placed in-service date, with a special emphasis on the relationship between the proposed regulations and previously released Revenue Ruling 99-5. Last, we believe the preamble's language misconstrues the purpose of the TCJA's full-expensing provision. The proposed regulation preamble imposes rules which define the acquisition date as the written binding contract date which is a misapplication of the TCJA and its goals.

Thank you for your consideration of these issues. Please contact me at (comstocks@api.org) with any questions or to help coordinate and find a time for us to connect.

Sincerely,

Stephen Comstock
Director of Tax and Accounting Policy
American Petroleum Institute
Washington, DC

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Issue: Prop. Reg. § 1.168(k)-2(b)(3)(iii)(A)(1) adds the words “or a predecessor” to the language of the Internal Revenue Code. This additional requirement is not found in the legislative history.

Proposed Regulation: Prop. Reg. § 1.168(k)-2(b)(3)(iii) — Used Property Acquisition Requirements; Prop. Reg. § 1.168(k)-2(b)(3)(iii)(A)(1) — Used Property Acquisition Requirements (In General)

Explanation/Recommendation: API and its members suggest the deletion of the words “or a predecessor” in this section of final regulations, with conforming changes elsewhere, to bring the requirements into alignment with the substantive requirements under the Code. To the extent it would be appropriate to apply the concept of a predecessor here, we think the word “taxpayer” would encompass that concept under general tax principles and, as applicable, the common law.

However, if “or a predecessor” is retained, we think the term “predecessor” should be comprehensively defined for this purpose, with clarification specifically as to whether and when a “predecessor” relationship would exist between a partner and a partnership or a shareholder and a corporation as a result of a transfer of property in either direction (including a taxable transfer). Additionally, clarification should be provided as to whether the term “predecessor” applies to the seller and/or the buyer with respect to a partnership that holds purchased assets after a Rev. Rul. 99-5, Situation 1 transaction.

Issue: Prop. Reg. § 1.168(k)-2(b)(3)(iii)(B)(1) states that property is defined as used if the taxpayer or any predecessor in time prior to the acquisition of the property by the taxpayer or predecessor if either the taxpayer or predecessor had a depreciable interest in the property. It is irrelevant whether the taxpayer or predecessor actually claimed depreciation deductions for the property.

Proposed Regulation: Prop. Reg. § 1.168(k)-2(b)(3)(iii)(B)(1) — Property Was Not Used By the Taxpayer at any Time Prior to Acquisition

Explanation/Recommendation: In response to Treasury's request for comments on this point, API and its members believe there should be a safe harbor look-back period of 5 years from the placed in service date for determination of whether there was a prior depreciable interest in the property, with a presumption (rebuttable through clear and convincing evidence) that neither the taxpayer nor a predecessor (if applicable) held a depreciable interest in the property before the beginning of that period.

A safe harbor is justified due to the substantial administrative burden that planning for and satisfying an open-ended inquiry would place on taxpayers, who generally are required to prove their entitlement to deductions. In reality, business practices generally do not dictate the reacquisition of particular assets or the long-term retention of detailed records of previously owned property.

However, in those rare instances where a reacquisition occurs more than 5 years after prior ownership, including potentially abusive situations, clear and convincing evidence of such prior ownership (e.g., transfer documents for the prior ownership) would rebut the presumption of no prior interest. And, as a practical matter, opportunities for abusive transfers and reacquisitions more than 5 years apart would present limited value due to the delay between the deductions and the phase out schedule under section 168(k)(6).

A safe harbor period of 5 years is consistent with the periods selected in other contexts to address similar issues. See, e.g., Treas. Reg. § 1.1001-3(f)(3) (disregarding modifications occurring more than five-years apart when determining if multiple modifications are significant); Treas. Reg. § 1.7874-8(g)(4) (for inversion gain purposes, establishing a 36-month look-back period to account for prior acquisitions); section 302(c)(2)(A)(ii) (10-year period for determining whether shareholder has terminated its interest in a corporation for purposes of applying section 302(a)).

Issue: Prop. Reg. § 1.168(k)-2(f)(1)(iii) sets forth rules which states: 1) if property is transferred to a partnership in a section 721(a) transaction and 2) the partnership also has a person as a partner, other than the transferor, and that person previously held a depreciable interest in the property the year it is placed into service then the allowable bonus depreciation is allocated entirely to the transferor and not to the partnership.

Proposed Regulation: Prop. Reg. § 1.168(k)-2(f)(1) — Property Placed in Service and Disposed of in the Same Taxable Year

Explanation/Recommendation: The preamble to the proposed regulations states that Situation 1 of Rev. Rul. 99-5 is a fact pattern that would fall under this proposed rule. The preamble also states that the rationale for this rule is that allocating any portion of the deduction to a partner who previously had a depreciable interest in the property would be inconsistent with the requirement of no prior use by the taxpayer in section 168(k)(2)(E)(ii)(I).

The requirement under this proposed rule that the transferred property be placed in service by the transferor in the same taxable year as the section 721(a) transaction would seemingly not be satisfied by the buyer in a Rev. Rul. 99-5, Situation 1 transaction, contrary to the stated intent of the preamble. In such a transaction, the buyer is deemed to transfer the purchased assets to the partnership immediately after the purchase, and the buyer never uses the assets outside of the partnership.

Due to the conflicting language of Prop. Reg. § 1.68(k)-2(f)(1)(iii) and Rev. Rul. 99-5 API and its members believe the proposed regulation's language should use the term “acquired” rather than “placed in service.” This change would ensure that the rule reaches but does not exceed its intended scope. With or without the change, this rule would apply only to used property (i.e., property in which another person already had a depreciable interest), so the “purchase” requirements of section 179(d)(2) would need to be satisfied in any case in order for there to be any “allowable” bonus depreciation under this rule.

Issue: Property Subject to Issue #3 Should be Treated as Section 704(c) Property

Proposed Regulation: Prop. Reg. § 1.168(k)-2(f)(1)(iii) — Property Placed in Service and Disposed of in the Same Taxable Year (Section 168(i)(7) Transactions)

Explanation/Recommendation: API and its members believe that property that is subject to the rule described under Issue #3 should be treated as section 704(c) property in the hands of the partnership, despite the facts that (1) a transferor may not otherwise be allowed any depreciation on the property outside of the partnership and (2) such treatment could entitle a non-contributing partner who previously held a depreciable interest in the property to curative or remedial allocations of depreciation with respect to the property. Such treatment is necessary because there is no other mechanism under the Code or regulations to properly account for the built-in gain that would arise from allocating all bonus depreciation on the property to the contributor outside of the partnership.

We think the final regulations should clarify this point.

Issue: The Prop. Reg. § 1.168(k)-2(f)(1)(iv) examples should include an illustration of issue #3 and the application of the proposed regulation to Rev. Rul. 99-5 situation 1 transaction.

Proposed Regulation: Prop. Reg. § 1.168(k)-2(f)(1)(iii) — Property Placed in Service and Disposed of in the Same Taxable Year (Section 168(i)(7) Transactions); Prop. Reg. § 1.168(k)-2(f)(1)(iv) — Examples

Explanation/Recommendation: API and its member companies believe the examples in Prop. Reg. § 1.168(k)-2)(f)(1)(iv) should include an illustration of how the rule described under Issue 3 would apply to a Rev. Rul. 99-5, Situation 1 transaction. Such an example would permit taxpayers to rely on actual text of the regulations rather than discussion in a preamble (potentially, only the preamble to the proposed regulations) regarding the rule's applicability to a Rev. Rul. 99-5, Situation 1 transaction.

Issue: The stated preamble misinterprets the purpose of the full-expensing provisions of the Tax Cuts and Jobs Act (“TCJA”)

Proposed Regulation Preamble: “Because of the clear language of section 13201(h)(1) of the Act regarding written binding contracts, the proposed regulations also provide that property that is manufactured, constructed, or produced for the taxpayer by another person under a written binding contract that is entered into prior to the manufacture, construction, or production of the property for use by the taxpayer in its trade or business or for its production of income is acquired pursuant to a written binding contract. Further, if the written binding contract states the date on which the contract was entered into and a closing date, delivery date, or other similar date, the date on which the contract was entered into is the date the taxpayer acquired the property.”¹

Explanation/Recommendation: As stated in the Conference Report (p. 232), “The Committee believes that providing full expensing for certain business assets lowers the cost of capital for tangible property used in a trade or business. With lower costs of capital, the Committee believes that businesses will be encouraged to purchase equipment and other assets, which will promote capital investment and provide economic growth. The Committee also believes that full expensing for certain business assets will eliminate depreciation recordkeeping requirements for such assets.”

The bonus depreciation provisions have historically provided guidance for property acquired pursuant to a written binding contract AND for self-constructed property regardless of whether that property was manufactured, constructed, or produced for the taxpayer by another person OR manufactured, constructed, or produced by the taxpayer for its own use. We believe that Treasury has misinterpreted the intent of Congress by the narrowly defining the acquisition date for property that was manufactured, constructed, or produced for the taxpayer by another person as the written binding contract date.

Pre-Tax Cuts and Jobs Act (“TCJA”) regulations provided that assets acquired after the appropriate effective date of the bonus rules qualified for bonus depreciation unless there was a written binding contract to purchase the assets in place before the effective date of the bonus rules. In contrast to these rules, different rules applied to self-constructed assets and assets that are constructed for the taxpayer by another person where construction begins after the written binding contract was executed. In these cases the contract was irrelevant and acquisition date was determined when significant, physical work began on the asset. To remedy the treatment of self-constructed assets constructed for the taxpayer by another person where construction begins after the contract is executed, we recommend revising the proposed regulations to provide that property that is manufactured, constructed, or produced for the taxpayer by another person under a written binding contract that is entered into prior to the manufacture, construction, or production of the property for use by the taxpayer in its trade or business (or for its production of income) is considered to be manufactured, constructed, or produced by the taxpayer. Furthermore, we recommend that final regulations incorporate the self-constructed property component rule provided in Revenue Procedure 2011-26.