January 15, 2018
Section 181 property affected by Tax Cuts and Jobs Act
The "Tax Cuts and Jobs Act" (H.R. 1) (the Act) made significant changes to bonus depreciation, which affects Section 181 property (e.g., certain televisions programs, films and live theatrical productions).
Section 181 previously permitted companies to immediately deduct costs incurred for films, television programs and live theatrical productions that had at least 75% of certain compensation costs incurred in the United States. Taxpayers should evaluate the changes to the bonus depreciation provisions as they impact Section 181 property and model the effect of the provisions to enable timely planning.
Temporary 100% expensing of certain business assets
Bonus depreciation increases from 50% to 100% for "qualified property" acquired and placed in service after September 27, 2017, and before 2023. The Act provides that certain used property will qualify for bonus depreciation. The increased expensing phases down starting in 2023 by 20 percentage points for each of the four following years. A transition rule allows for an election to apply 50% expensing for the first tax year ending after September 27, 2017. For a comprehensive discussion of this provision, see Tax Alert 2017-2131.
Specifically, the term "qualified property" has been expanded to include qualified film, television and live theatrical productions for which a deduction otherwise would have been allowable under Section 181. The incorporation of Section 181 into the bonus depreciation provisions of Section 168(k) has several important implications and planning opportunities.
First, note that Section 168(k) leverages Section 181 in its entirety, except for its cost limitation and its expiration date. Thus, there is no cost limit for bonus depreciation purposes for qualifying Section 181 property. Also, because only qualified Section 181 property qualifies, the provisions in Section 168(k) permitting a deduction for used property, absent guidance to the contrary, should not apply to Section 181 property. Section 181 does not include used property that has already been commercially exhibited.
Second, Section 181 costs are now only recovered after the property is placed in service and not when incurred. Thus, taxpayers should capitalize development costs and recover them through bonus depreciation when the property is placed in service or, if no production occurs, under Revenue Procedure 2004-36. For purposes of bonus depreciation, "placed in service" is expressly defined by Section 168(k)(2)(H) as the date of initial release, broadcast or staged performance, as applicable.
Third, bonus depreciation will only apply to property that is qualified Section 181 property. That said, Section 168(k)(2)(A)(i)(IV) and (V) do not appear to require an election under Section 181 in order for such property to satisfy the definition of "qualified property" for bonus depreciation purposes. Thus, it appears that taxpayers will not be able to control which property meets the definition of "qualified property" by making selective Section 181 elections. In the past, taxpayers could choose to exclude a title from Section 181 by not making an election. Going forward, such title will be subject to bonus depreciation unless an election is made out of bonus depreciation for all qualified Section 181 property under Section 168(k)(7).1 However, an alternative position may be available that a lower "class" of property (e.g., all films or all television programs) may be able to elect out of bonus depreciation. We are looking into this position and seeking additional guidance on the application of the election-out provisions to qualified Section 181 property.
Fourth, it is very important to track the relevant time period for each property because Section 168(k) has both an acquisition and placed in service requirement. Full 100% bonus depreciation will begin for Section 181 property that is acquired and placed in service after September 27, 2017. For qualified property that is acquired before September 27, 2017, costs may only be recovered under the general depreciation methods provided by Section 167 (e.g., income forecast, straight line, etc.). (Note, the IRS may issue rules, as it did previously in Revenue Procedure 2011-26, that permit cost components to be treated as incurred at a later date, which may make them eligible for a greater bonus depreciation allowance.) At this time, it is not clear when property will be treated as "acquired" and we will be providing additional guidance soon on this important point.
The chart below provides a summary of the applicable bonus depreciation recovery percentages for qualified Section 181 property:
Companies in the media industry will need to closely examine these provisions in order to properly determine the application of bonus depreciation to qualified Section 181 property.
1Until further guidance is issued, taxpayers may want to consider making the election and attaching the detailed election statements required by Section 181. While the general bonus depreciation rules provide that elections out of bonus depreciation are made on a class-of-property basis, guidance on bonus depreciation as it applies to Section 181 property may indicate that a Section 181 election is still required, leaving the potential position that a taxpayer that does not want to have bonus depreciation applied to a particular film may achieve this result by not including the film on the protective election statement.