This Alert supplements Tax Alert 2018-0106, which described how the bonus depreciation rules apply to qualified Section 181 property. This Alert highlights the application of Section 181 to qualifying properties for which principal photography had commenced before the statute expired on December 31, 2016. Taxpayers may have mistakenly believed that no further costs could be deducted under Section 181. Costs incurred for such projects to finish production in 2017, however, are deductible in 2017 under Section 181. This is provided by the express language of the termination provision under Section 181(g) and by former Temp. Treas. Reg. Section 1.181-6T.

Section 181(g) states, "This section shall not apply to qualified film and television productions or qualified live theatrical productions commencing after December 31, 2016." The temporary regulations indicate that "commencing after" turns on whether principal photography has begun. In general, principal photography is when the actual shooting of a film or television program takes place. For animated programming, the regulations state that "keyframe animation, in-between animation, animation photography, and the recording of voice[-]acting performances" will be considered as similar to principal photography. See Treas. Reg. Section 1.181-3(d). The regulations also provide guidance for productions with live action and animation.

Media and entertainment taxpayers preparing 2017 tax returns and provisions need to be aware that they still may expense certain costs incurred for qualified Section 181 property in 2017 under Section 181 if principal photography began before January 1, 2017 (subject to the $15 million cap). These expenses remain deductible even though Section 181 sunset on December 31, 2016. The timing for each production is important because previously deducted Section 181 costs for properties that did not begin principal photography before December 31, 2016, should have been recaptured and added back to 2016 taxable income. See Treas. Reg. Section 1.181-4(a)(2).

Consider two examples. First, $5 million of development and production costs is incurred on a qualified film in 2016 and principal photography commences on December 1, 2016. In 2017, an additional $4 million of costs are incurred before completion of the film. The $4 million of costs incurred in 2017 are deductible under Section 181. Second, a qualifying TV series produced 15 complete episodes and principal photography commenced on Episode 16 as of December 31, 2016. In 2017, $1 million was spent finishing Episode 16. The 2017 costs should be fully deductible under Section 181 (taking into account the $15 milion limitation under Section 181(a)(2)(A)). Note, each episode is treated as a separate property under Section 181(d)(2)(B)(ii). It appears that each episode should also be treated as a separate property for applying the commencement rule of Section 181(g).

As provided in Tax Alert 2018-0106, "qualified property" for purposes of bonus depreciation under Section 168(k) has been expanded to include qualified film, television and live theatrical productions for which a deduction otherwise would have been allowable under Section 181. Please consult Tax Alert 2018-0106 for the associated implications and planning opportunities.

Implications

Companies in the media industry will need to closely examine these provisions in order to properly determine the application to qualified Section 181 property associated with principal photography.

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