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Bonus Depreciation and §754 Step-ups to Partnership Assets

Bonus Depreciation and §754 Step-ups to Partnership Assets

By: John Conner

Bonus depreciation, now set at 100% through 2022, is permitted on both tangible personal and real property having a MACRS class life of 20 years or less. It is not, however, allowed for intangible assets such as goodwill which must instead be amortized over 180- months pursuant to Code §197 (commencing with the month that the asset is first placed in service).

Comment: This “refresher” on the bonus depreciation rules involving assets acquired indirectly through a §754 step-up is taken from the completely revised “2022 COMPLETE GUIDE TO DEPRECIATION, AMORTIZATION & TRANSFERS OF PROPERTY – ISSUES, ANSWERS & PLANNING STRATEGIES” which is now available for purchase for your firm’s tax department.

Before 9/28/17, “used” assets were not eligible for bonus depreciation (which was set at a rate of 50% at that time). Instead, the “original use” (i.e., initial use) of the asset had to have commenced with the taxpayer seeking to claim bonus depreciation (and, this included lessees who decided to purchase the asset at the end of the rental period, such as a vehicle or equipment, so long as the lessee was the first (i.e., “original”) taxpayer to have ever used the property in question).

With the passage of the TCJA, however, the outright purchase of previously-used assets is now permitted when claiming bonus depreciation. But, what about the “deemed acquisition of assets” where a partnership interest was transferred in a taxable sale or exchange? Under the “aggregate theory” of partnership taxation, the entity’s owners are treated as possessing an indirect interest in each and every one of the assets that the partnership has on its balance sheet. So, has not the purchaser of a partnership interest essentially bought the selling partner’s underlying share of their right to each and every one of the entity’s assets? And, if so, how does that impact the use of bonus depreciation on the assets (or, portion thereof with regard to a “step-up in basis”) deemed purchased?

The “answer” is that, with a valid Sec. 754 election, there is a step-up to the “inside bases” of the partnership assets deemed acquired indirectly when a partnership interest is purchased (or, inherited, but not received by gift since there is no “step-up” as to the donee’s carryover basis). This is reflected on the Form 4562 where a “Sec. 754 adjustment” is listed in the same fashion as any other purchased (depreciable) asset. Before changes made by the TCJA, “used” assets were not eligible for bonus depreciation. But, for assets acquired and placed into service after 9/27/17, bonus depreciation will be allowed for outright purchases of previously-used assets. The Service has now clarified as to how this change would apply to the acquisition of an interest in an existing partnership holding previously-used assets, to the distribution of such assets from an existing partnership, or to similar transactions. As a result, bonus depreciation is now allowed on used assets held by the partnership where the Sec. 754 adjustment is made pursuant to Code §743 (i.e., purchases or inheritances of a partnership interest) as opposed to Code §734 (i.e., where the step- up is due to “disappearing basis” or gain resulting from a liquidating distribution of property to an exiting partner).