Special Depreciation Allowance, 51727-51748 [06-7333]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 71, Number 169 (Thursday, August 31, 2006)]
[Rules and Regulations]
[Pages 51727-51748]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 06-7333]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9283]
RIN 1545-BB57


Special Depreciation Allowance

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains final regulations relating to the 
depreciation of property subject to section 168 of the Internal Revenue 
Code (MACRS property) and the depreciation of computer software subject 
to section 167. Specifically, these final regulations provide guidance 
regarding the additional first year depreciation allowance provided by 
sections 168(k) and 1400L(b) for certain MACRS property and computer 
software. The regulations reflect changes to the law made by the Job 
Creation and Worker Assistance Act of 2002, the Jobs and Growth Tax 
Relief Reconciliation Act of 2003, the Working Families Tax Relief Act 
of 2004, the American Jobs Creation Act of 2004, and the Gulf 
Opportunity Zone Act of 2005.

DATES: Effective Dates: These regulations are effective August 31, 
2006.
    Applicability Dates: For dates of applicability, see Sec. Sec.  
1.167(a)-14(e), 1.168(d)-1(d), 1.168(d)-1T(d), 1.168(k)-1(g), 1.169-
3(g), and 1.1400L(b)-1(g).

FOR FURTHER INFORMATION CONTACT: Douglas Kim, (202) 622-3110 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

[[Page 51728]]

Background

    This document contains amendments to 26 CFR part 1. On September 8, 
2003, the IRS and Treasury Department published temporary regulations 
(TD 9091) in the Federal Register (68 FR 52986) relating to the 
additional first year depreciation deduction provisions of sections 
168(k) and 1400L(b) of the Internal Revenue Code (Code). On the same 
date, the IRS published a notice of proposed rulemaking (REG-157164-02) 
cross-referencing the temporary regulations in the Federal Register (68 
FR 53008). On March 1, 2004, the temporary regulations (TD 9091) were 
amended by the temporary regulations (TD 9115) published by the IRS and 
Treasury Department in the Federal Register (69 FR 9529) relating to 
the depreciation of property acquired in a like-kind exchange or as a 
result of an involuntary conversion, and the notice of proposed 
rulemaking (REG-157164-02) was amended by the notice of proposed 
rulemaking (REG-106590-00, REG-138499-02) published by the IRS in the 
Federal Register (69 FR 9560) cross-referencing TD 9115. No public 
hearing was requested or held. Several comments responding to the 
notice of proposed rulemaking (REG-157164-02) were received. After 
consideration of all the comments, the proposed regulations (REG-
157164-02) as amended by this Treasury decision are adopted as final, 
and the corresponding temporary regulations (TD 9091) are removed. The 
revisions are discussed below. Additionally, minor changes are made to 
the temporary regulations (TD 9115) to reflect the proper cites of the 
final regulations.
    Section 1400N(d), which was added to the Code by section 101(a) of 
the Gulf Opportunity Zone Act of 2005, Public Law 109-135 (119 Stat. 
2577), generally allows a 50-percent additional first year depreciation 
deduction (GO Zone additional first year depreciation deduction) for 
qualified Gulf Opportunity Zone property. Notice 2006-67 (2006-33 
I.R.B. 248) provides guidance with respect to the GO Zone additional 
first year depreciation deduction. Because Notice 2006-67 contains 
citations to the temporary regulations under section 168(k) (TD 9091), 
the IRS intends to update Notice 2006-67 to change these citations to 
this Treasury decision.

Explanation of Provisions

    Section 167 allows as a depreciation deduction a reasonable 
allowance for the exhaustion, wear, and tear of property used in a 
trade or business or held for the production of income. The 
depreciation allowable for tangible, depreciable property placed in 
service after 1986 generally is determined under section 168 (MACRS 
property). The depreciation allowable for computer software that is 
placed in service after August 10, 1993, and is not an amortizable 
section 197 intangible is determined under section 167(f)(1).
    Section 168(k)(1) allows a 30-percent additional first year 
depreciation deduction for qualified property acquired after September 
10, 2001, and, in most cases, placed in service before January 1, 2005. 
Section 168(k)(4) allows a 50-percent additional first year 
depreciation deduction for 50-percent bonus depreciation property 
acquired after May 5, 2003, and, in most cases, placed in service 
before January 1, 2005. Section 1400L(b) allows a 30-percent additional 
first year depreciation deduction for qualified New York Liberty Zone 
property (Liberty Zone property) acquired after September 10, 2001, and 
placed in service before January 1, 2007 (January 1, 2010, in the case 
of qualifying nonresidential real property and residential rental 
property).
    The final regulations provide the requirements that must be met for 
depreciable property to qualify for the additional first year 
depreciation deduction provided by sections 168(k) and 1400L(b). 
Further, the final regulations instruct taxpayers how to determine the 
additional first year depreciation deduction and the amount of 
depreciation otherwise allowable for eligible depreciable property. 
Unless specifically stated, references to the temporary regulations are 
to TD 9091.

Property Eligible for the Additional First Year Depreciation Deduction

    The final regulations retain the rules contained in the temporary 
regulations providing that depreciable property must meet four 
requirements to be qualified property under section 168(k)(2) (property 
for which the 30-percent additional first year depreciation deduction 
is allowable) or 50-percent bonus depreciation property under section 
168(k)(4) (property for which the 50-percent additional first year 
depreciation deduction is allowable). These requirements are: (1) The 
depreciable property must be of a specified type; (2) the original use 
of the depreciable property must commence with the taxpayer after 
September 10, 2001, for qualified property or after May 5, 2003, for 
50-percent bonus depreciation property; (3) the depreciable property 
must be acquired by the taxpayer within a specified time period; and 
(4) the depreciable property must be placed in service by a specified 
date.
    Several commentators questioned whether these requirements must be 
met in the year in which the depreciable property is placed in service 
by the taxpayer. The statute is clear that additional first year 
depreciation is allowed in the taxable year in which qualified property 
or 50 percent bonus depreciation property is placed in service by the 
taxpayer for use in its trade or business or for production of income. 
Therefore, only property that meets all of these requirements in the 
year in which placed in service by the taxpayer for use in its trade or 
business or for production of income is allowed additional first year 
depreciation in the year the property is placed in service by the 
taxpayer for use in its trade or business or for production of income. 
In response to this comment, the final regulations state more 
explicitly that all of the requirements must be met in the first 
taxable year in which the property is subject to depreciation by the 
taxpayer whether or not depreciation deductions are allowable.

Property of a Specified Type

    The final regulations retain the rules contained in the temporary 
regulations providing that qualified property or 50-percent bonus 
depreciation property must be one of the following: (1) MACRS property 
that has a recovery period of 20 years or less; (2) computer software 
as defined in, and depreciated under, section 167(f)(1); (3) water 
utility property as defined in section 168(e)(5) and depreciated under 
section 168; or (4) qualified leasehold improvement property 
depreciated under section 168.
    The final regulations also retain the rules contained in the 
temporary regulations providing that qualified property or 50-percent 
bonus depreciation property does not include: (1) Property excluded 
from the application of section 168 as a result of section 168(f); (2) 
property that is required to be depreciated under the alternative 
depreciation system of section 168(g) (ADS); (3) any class of property 
for which the taxpayer elects not to deduct the 30-percent or 50-
percent additional first year depreciation; or (4) qualified New York 
Liberty Zone leasehold improvement property as defined in section 
1400L(c).
    Property is required to be depreciated under the ADS if the 
property is described under section 168(g)(1)(A) through (D) or if 
other provisions of the Code require depreciation for the property to 
be determined under the ADS (for example, section 263A(e)(2)(A) or 
section 280F(b)(1)). A commentator

[[Page 51729]]

questioned whether depreciable property held by taxpayers that made the 
election under section 263A(d)(3) should be excluded from eligibility 
for the additional first year depreciation deduction. Section 
263A(e)(2)(A) provides that if a taxpayer (or a related person) makes 
an election under section 263A(d)(3) (relating to an election not to 
apply section 263A to any plant produced in any farming business 
carried on by the taxpayer), the ADS applies to all property of the 
taxpayer used predominantly in the farming business and placed in 
service in any taxable year during which any such election is in 
effect. Section 168(k) does not exclude property for which the section 
263A(d)(3) election was made from the application of section 
168(k)(2)(D)(i), which provides that property required to be 
depreciated under the ADS is not qualified property and 50-percent 
bonus depreciation property. For this reason, the final regulations do 
not adopt the suggestion that depreciable property held by taxpayers 
that made the election under section 263A(d)(3) is eligible for the 
additional first year depreciation deduction. Another commentator 
requested clarification as to whether the reference to ``property 
described in section 263A(e)(2)(A)'' in Sec.  1.168(k)-
1T(b)(2)(ii)(A)(2) includes only property held by a taxpayer that has 
made an election under section 263A(d)(3). In response to this comment, 
the final regulations clarify that if the taxpayer (or a related 
person) has made the election under section 263A(d)(3), the property 
described in section 263A(e)(2)(A) is not eligible for the additional 
first year depreciation deduction.

Original Use

    The final regulations clarify and make conforming changes to the 
original use rules in the temporary regulations in several respects. 
First, a commentator inquired whether the rule providing that the cost 
of reconditioned or rebuilt property acquired by the taxpayer does not 
satisfy the original use requirement also applies to self-constructed 
property. A few commentators inquired whether the 20-percent test for 
determining whether property is reconditioned or rebuilt applies to 
self-constructed property. The IRS and Treasury Department intended 
that these rules apply to the cost of any reconditioned or rebuilt 
property, whether the taxpayer originally acquired the property or 
self-constructed the property. Accordingly, the final regulations 
clarify that the cost of reconditioned or rebuilt property does not 
satisfy the original use requirement and that the 20-percent test 
applies to acquired or self-constructed property.
    Second, Example 2 of Sec.  1.168(k)-1T(b)(3)(v) provides that 
property held primarily for sale to customers in the ordinary course of 
a person's business (inventory) does not constitute a use for purposes 
of the original use requirement. A commentator noted that this rule is 
not in the operative rules of the temporary regulations. In response to 
this comment, the final regulations make the rule explicit and provide 
that if a person initially acquires new property and holds the property 
as inventory and a taxpayer subsequently acquires the property from the 
person for use primarily in the taxpayer's trade or business or 
primarily for the taxpayer's production of income, the taxpayer is 
considered the original user of the property. The final regulations 
also provide that if a taxpayer initially acquires new property and 
holds the property as inventory and then subsequently withdraws the 
property from inventory and uses the property primarily in the 
taxpayer's trade or business or primarily for the taxpayer's production 
of income, the taxpayer is considered the original user of the 
property. In both situations, the final regulations provide that the 
original use of the property by the taxpayer commences on the date on 
which the taxpayer uses the property primarily in the taxpayer's trade 
or business or primarily for the taxpayer's production of income.
    A commentator questioned whether Example 2 in Sec.  1.168(k)-
1T(b)(3)(v) is the appropriate place to resolve the issue of the tax 
treatment of demonstrator automobiles for depreciation and other 
purposes when the issue may have a potential broader scope and 
significance that may continue to arise long after the additional first 
year depreciation under section 168(k) has ceased to be available. The 
IRS and Treasury Department believe that this example illustrates only 
the concept that if property is held by a person as inventory and then 
sold to a taxpayer for use in the taxpayer's trade or business, the 
taxpayer is the original user of the property, and, therefore, that 
this example is in the appropriate place.
    Third, the final regulations retain the special rules contained in 
the temporary regulations for certain sale-leaseback transactions and 
syndication transactions. A commentator suggested that the title of 
Sec.  1.168(k)-1T(b)(3)(iii)(B), ``Syndication transaction,'' should be 
changed in the final regulations to reflect that this rule, by its 
terms, can apply to any sale of property within three months after the 
date on which it is placed in service, regardless of whether that sale 
constitutes a syndication. The final regulations adopt this suggestion 
and modify the titles of, and make conforming changes to, the 
applicable paragraphs. Similar changes also are made to the paragraphs 
relating to the placed-in-service date requirement.
    Fourth, the final regulations modify the provision in the temporary 
regulations to implement section 403(a) of the Working Families Tax 
Relief Act of 2004, (Pub. L. 108-311, 118 Stat. 1166) (October 4, 2004) 
(WFTRA) and section 337 of the American Jobs Creation Act of 2004 (Pub. 
L. 108-357, 118 Stat. 1418) (October 22, 2004) (AJCA). Section 403(a) 
of the WFTRA amended section 168(k) by adding the provision in section 
168(k)(2)(E)(iii). Section 403(f) of the WFTRA provides that this 
amendment is effective as if included in the provisions of the Job 
Creation and Worker Assistance Act of 2002 (Pub. L. 107-147, 116 Stat. 
21) (March 9, 2002) (JCWAA). Section 337(a) of the AJCA amended the 
syndication transaction provision in section 168(k)(2)(E)(iii)(II) by 
adding at the end the following: ``(or, in the case of multiple units 
of property subject to the same lease, within 3 months after the date 
the final unit is placed in service, so long as the period between the 
time the first unit is placed in service and the time the last unit is 
placed in service does not exceed 12 months).'' Section 337(b) of the 
AJCA provides that this amendment is effective for property sold after 
June 4, 2004.
    Fifth, if property placed in service by a person is sold and leased 
back within three months, and a syndication transaction occurs within 
three months after the sale-leaseback, a commentator questioned whether 
the purchaser of the property in the syndication transaction is 
considered the original user of the property and whether the property 
is treated as having been placed in service by the purchaser in the 
syndication transaction. Pursuant to Sec. Sec.  1.168(k)-
1T(b)(3)(iii)(C) and (5)(ii)(C), the purchaser of the property in the 
syndication transaction is considered the original user of the property 
and the property is treated as having been placed in service by the 
purchaser in the syndication transaction. The final regulations retain 
this rule and provide an example illustrating both the original use and 
the placed in service aspects of this situation.

[[Page 51730]]

    Finally, the final regulations retain the rule contained in the 
temporary regulations providing that if, in the ordinary course of its 
business, a taxpayer sells fractional interests in qualified property 
or 50-percent bonus depreciation property to unrelated third parties, 
each first fractional owner of the property is considered as the 
original user of its proportionate share of the property. A commentator 
questioned whether the rule requiring the sale to be to unrelated third 
parties means that the purchasers must be unrelated to the seller, the 
purchasers must be unrelated to each other, or both. The IRS and 
Treasury Department intended that the purchasers be unrelated to the 
seller. Accordingly, the final regulations clarify this point.
    A commentator questioned whether there are circumstances when the 
placed-in-service year of property is before the taxable year of 
original use. Pursuant to Sec.  1.46-3(d)(1)(ii), property is 
considered placed in service in the taxable year in which the property 
is placed in a condition or state of readiness and availability for a 
specifically assigned function, whether in a trade or business, in the 
production of income, in a tax-exempt activity, or in a personal 
activity. Original use begins when new property is placed in service. 
Consequently, the placed-in-service year of new property cannot be 
before the taxable year in which original use of the property occurs.

Acquisition of Property

    The final regulations modify the acquisition dates in the temporary 
regulations to reflect section 405 of the Gulf Opportunity Zone Act of 
2005 (Pub. L. 109-135, 119 Stat. 2577) (December 21, 2005) (GOZA). 
Section 405(a)(1) of the GOZA amended section 168(k)(4)(B)(ii) to 
provide that 50-percent bonus depreciation property is property (I) 
acquired by the taxpayer after May 5, 2003, and before January 1, 2005, 
but only if no written binding contract for the acquisition of the 
property was in effect before May 6, 2003, or (II) acquired by the 
taxpayer pursuant to a written binding contract which was entered into 
after May 5, 2003, and before January 1, 2005. Section 405(b) provides 
that this amendment is effective as if included in section 201 of the 
Jobs and Growth Tax Relief and Reconciliation Act of 2003 (Pub. L. 108-
27, 117 Stat. 752) (May 28, 2003).

Binding Contracts

    The final regulations also modify in three respects the rules 
contained in the temporary regulations defining a binding contract. 
First, the temporary regulations provide that if a contract provides 
for a full refund of the purchase price in lieu of any damages 
allowable by law in the event of breach or cancellation by the seller, 
the contract is not considered binding. A commentator suggested that 
this rule should apply to a breach or cancellation by the buyer, not 
the seller. However, the IRS and Treasury Department believe that this 
rule relates to a breach or cancellation by either party. Accordingly, 
the final regulations provide that if a contract provides for a full 
refund of the purchase price in lieu of any damages allowable by law in 
the event of breach or cancellation, the contract is not considered 
binding.
    Second, with respect to a contract subject to a condition, the 
temporary regulations provide that a contract that imposes significant 
obligations on the taxpayer or a predecessor will be treated as binding 
notwithstanding the fact that insubstantial terms remain to be 
negotiated by the parties to the contract. A commentator questioned 
whether this rule implies that a contract that imposes significant 
obligations will not be treated as binding if substantial terms remain 
to be negotiated. The IRS and Treasury Department believe that this 
implication was not intended. As a consequence, the final regulations 
clarify this rule by providing that a contract that imposes significant 
obligations on the taxpayer or a predecessor will be treated as binding 
notwithstanding the fact that certain terms remain to be negotiated by 
the parties to the contract.
    Third, with respect to a supply agreement, a commentator suggested 
that the existence of agreed pricing terms should not be relevant in 
determining whether or not a supply agreement is a binding contract, 
except to the extent that their absence causes the contract not to be 
enforceable under local law. The commentator further suggested that if 
the existence of pricing terms is considered relevant to the result in 
the example of the operative rule and in some of the examples that 
illustrate the application of the rule, that requirement should be 
stated in the operative rule, and if not relevant, the references to 
pricing terms should be deleted. Pricing terms are not relevant in 
determining whether a supply agreement is a binding contract for 
purposes of these regulations. Accordingly, the final regulations adopt 
the suggestion by eliminating the reference to agreed pricing terms in 
the example of the operative rule. While the examples that illustrate 
the application of the rule continue to contain the agreed price as a 
fact, the conclusions in these examples depend upon only whether or not 
the quantity and the design specification of the property to be 
purchased are specified.

Self-Constructed Property

    With respect to self-constructed property, the final regulations 
clarify the rules in the temporary regulations in several respects. 
First, with respect to property described in section 168(k)(2)(B) 
(longer production period property) or section 168(k)(2)(C) (certain 
aircraft), the final regulations clarify that if a taxpayer enters into 
a written binding contract after September 10, 2001, and before January 
1, 2005, with another person to manufacture, construct, or produce such 
property and the manufacture, construction, or production begins after 
December 31, 2004, the taxpayer has acquired the property pursuant to a 
written binding contract entered into after September 10, 2001, and 
before January 1, 2005 (for qualified property) or after May 5, 2003, 
and before January 1, 2005 (for 50-percent bonus depreciation 
property).
    Second, a commentator asked whether the rules in the temporary 
regulations providing for when construction begins are intended also to 
apply to manufacture and production because self-constructed property 
can be manufactured, constructed, or produced for purposes of the 
additional first year depreciation deduction. The IRS and Treasury 
Department intended these rules to apply to manufacture, construction, 
or production. Accordingly, the final regulations make this 
clarification.
    Third, the temporary regulations provide that construction of 
property begins when physical work of a significant nature begins and 
the determination of when physical work of a significant nature begins 
depends on the facts and circumstances. The temporary regulations also 
provide that physical work of a significant nature will not be 
considered to begin before the taxpayer incurs or pays more than 10 
percent of the total cost of the property (excluding the cost of any 
land and preliminary activities). Several commentators questioned 
whether this 10-percent test is a safe harbor. The preamble to the 
temporary regulations (68 FR 52987) states that the 10-percent test is 
a safe harbor. Consequently, the final regulations are clarified to 
provide that the 10-percent test is a safe harbor. Further, when 
another party manufactures, constructs, or produces property for the 
taxpayer, the final regulations clarify that the safe harbor test must 
be met by the taxpayer. Thus,

[[Page 51731]]

under the final regulations, a taxpayer can determine when manufacture, 
construction, or production of the property begins either (1) by using 
the 10 percent safe harbor or (2) by using its own facts and 
circumstances.
    Fourth, the final regulations retain the rules contained in the 
temporary regulations relating to components of self-constructed 
property. One of these rules is that if the binding contract to acquire 
a component is entered into, or the manufacture, construction, or 
production of a component begins, after September 10, 2001, for 
qualified property, or after May 5, 2003, for 50-percent bonus 
depreciation property, and before January 1, 2005, but the manufacture, 
construction, or production of the larger self-constructed property 
begins after December 31, 2004, the component qualifies for the 
additional first year depreciation deduction (assuming all other 
requirements are met) but the larger self-constructed property does 
not. In the case of a self-constructed component that is to be 
incorporated into a larger self-constructed property, some commentators 
noted that the applicability of this rule is limited. Specifically, one 
commentator stated that if the 10 percent test mentioned in the 
preceding paragraph is not a safe harbor test, then the only case in 
which self-constructed components could qualify for the additional 
first year depreciation deduction is one in which the taxpayer's pre-
January 1, 2005, costs are 10 percent or less of the total cost of the 
larger self-constructed property (but more than 10 percent of the total 
cost of the component). Another commentator stated that a self-
constructed component that is to be incorporated into a larger self-
constructed property may not be placed in service before the larger 
self-constructed property. The IRS and Treasury Department agree that 
the rule has limited applicability. The rule applies when the larger 
self-constructed property is property that is manufactured, 
constructed, or produced by the taxpayer for its own use and that is 
described in section 168(k)(2)(B) (longer production period property) 
or section 168(k)(2)(C) (certain aircraft) and, therefore, the property 
is eligible for the extended placed-in-service date of January 1, 2006.

Disqualified Transactions

    The final regulations clarify the disqualified transaction rules in 
the temporary regulations to reflect section 403(a) of the WFTRA. This 
section amended section 168(k) by adding section 168(k)(2)(E)(iv), 
which provides limitations related to users and related parties 
(disqualified transactions). Section 168(k)(2)(E)(iv) provides that the 
term qualified property does not include any property if: (I) the user 
of such property (as of the date on which the property is originally 
placed in service) or a person that is related (within the meaning of 
section 267(b) or 707(b)) to such user or to the taxpayer had a written 
binding contract in effect for the acquisition of the property at any 
time on or before September 10, 2001; or (II) in the case of property 
manufactured, constructed, or produced for such user's or person's own 
use, the manufacture, construction, or production of the property began 
at any time on or before September 10, 2001. Section 403(f) of the 
WFTRA provides that this amendment is effective as if included in the 
provisions of the JCWAA.
    Finally, the IRS and Treasury Department decided to add new 
examples to illustrate the above rules. Further, in Example 10 of Sec.  
1.168(k)-1T(b)(4)(v), a commentator inquired whether the taxpayer (S) 
is considered to be self-constructing the property, acquiring the 
property, or both. The IRS and Treasury Department intended to have the 
taxpayer both self-constructing and acquiring the property. The final 
regulations make this clarification.
    A commentator questioned whether the result in Example 10 of Sec.  
1.168(k)-1T(b)(4)(v) also would apply if before September 11, 2001, a 
partnership began construction of a power plant for its own use, then 
after September 10, 2001, and before completion of the plant, there is 
a technical termination of the partnership under section 708(b)(1)(B), 
and then subsequently the new partnership incurred additional 
expenditures to complete the construction of the power plant and placed 
the power plant in service before January 1, 2005. Assuming the 
terminated partnership and the new partnership are not related parties, 
the new partnership is considered to have acquired the uncompleted 
power plant and completed the construction of the power plant and, 
thus, the result in Example 10 of Sec.  1.168(k)-1T(b)(4)(v) will apply 
to the new partnership in this case. While the additional first year 
depreciation deduction for Liberty Zone property requires the property 
to be acquired by purchase, the same result would apply because for 
purposes of that requirement, Sec.  1.1400L(b)-1T(c)(5)(ii) treats the 
new partnership as acquiring the property by purchase and the final 
regulations retain this rule.

Placed-in-Service Date

    The final regulations retain the rule contained in the temporary 
regulations providing, pursuant to section 168(k)(2)(A)(iv) and section 
168(k)(4)(B)(iii), that qualified property or 50-percent bonus 
depreciation property is property that is placed in service by the 
taxpayer before January 1, 2005. The temporary regulations also provide 
that property described in section 168(k)(2)(B) (longer production 
period property) must be placed in service before January 1, 2006. The 
final regulations modify this extended placed-in-service date 
requirement in two respects. First, the final regulations reflect that 
the extended placed-in-service date of before January 1, 2006, also 
applies to property described in section 168(k)(2)(C) (certain 
aircraft), which was added to section 168(k) by section 336 of the 
AJCA. Second, the final regulations reflect that the extended placed-
in-service date of before January 1, 2006, is extended for one year to 
before January 1, 2007, for property to which Announcement 2006-29 
(2006-19 IRB 879) applies. Announcement 2006-29 applies to property 
described in section 168(k)(2)(B) or (C) that is either placed in 
service by the taxpayer or manufactured by a person in the Gulf 
Opportunity (GO) Zone, the Rita GO Zone, or the Wilma GO Zone, provided 
the taxpayer was unable to meet the December 31, 2005, placed-in-
service date deadline for such property as a result of Hurricane 
Katrina, Hurricane Rita, or Hurricane Wilma.

Qualified Leasehold Improvement Property

    The final regulations retain the rules contained in the temporary 
regulations relating to qualified leasehold improvement property. The 
temporary regulations provide that qualified leasehold improvement 
property means any improvement, which is section 1250 property, to an 
interior portion of a building that is nonresidential real property if, 
among other things, the improvement is made under or pursuant to a 
lease by the lessee (or any sublessee) of the interior portion, or by 
the lessor of that interior portion. A commentator questioned whether 
this rule means an improvement that is permitted or required by a 
lease. The IRS and Treasury Department believe that the improvement 
must be made under or pursuant to a lease, regardless of whether the 
improvement is permitted or required under the lease.

[[Page 51732]]

Computation of Additional First Year Depreciation Deduction and 
Otherwise Allowable Depreciation

    The final regulations retain the rules contained in the temporary 
regulations for determining the amount of the additional first year 
depreciation deduction and otherwise allowable depreciation deduction. 
In addition, the final regulations clarify that the additional first 
year depreciation deduction generally is allowable in the first taxable 
year in which the qualified property or 50-percent bonus depreciation 
property is placed in service by the taxpayer for use in its trade or 
business or for the production of income.

Election Not To Claim Additional First Year Depreciation Deduction

    With respect to the election not to claim the additional first year 
depreciation deduction, the final regulations retain the rules 
contained in the temporary regulations for making this election and for 
defining what is a class of property for purposes of the election. For 
any class of property that is qualified property, a taxpayer may elect 
out of the 30-percent additional first year depreciation deduction for 
any class of qualified property. For any class of property that is 50-
percent bonus depreciation property, a taxpayer may elect either to 
deduct the 30-percent, instead of the 50-percent, additional first year 
depreciation or to deduct no additional first year depreciation. A 
commentator asked whether a taxpayer with 50-percent bonus depreciation 
property must make two elections to elect not to deduct any additional 
first year depreciation. The final regulations clarify that only one 
election is needed to elect not to deduct both the 30-percent and 50-
percent additional first year depreciation for 50-percent bonus 
depreciation property.
    If a taxpayer elects not to deduct any additional first year 
depreciation for a class of property, another commentator asked whether 
the depreciation adjustments under section 56 apply to property 
included in such class for purposes of computing the taxpayer's 
alternative minimum taxable income. The non-applicability of the 
depreciation adjustments under section 56 provided by section 
168(k)(2)(G) applies only to qualified property or 50-percent bonus 
depreciation property. If a taxpayer elects not to deduct any 
additional first year depreciation for a class of property, the 
property included in such class is not qualified property or 50-percent 
bonus depreciation property. Accordingly, the final regulations provide 
that if a taxpayer elects not to deduct any additional first year 
depreciation for a class of property, the depreciation adjustments 
under section 56 apply to that property for purposes of computing the 
taxpayer's alternative minimum taxable income.
    The final regulations also include the procedures provided by 
section 3.04 of Rev. Proc. 2002-33 (2002-1 C.B. 963) for revoking an 
election not to deduct the additional first year depreciation for a 
class of property. These procedures provide that this election is 
revocable only with the prior written consent of the Commissioner of 
Internal Revenue and, to seek the Commissioner's consent, the taxpayer 
must submit a request for a letter ruling. However, the final 
regulations also provide an automatic 6-month extension from the due 
date of the taxpayer's Federal tax return (excluding extensions) for 
the placed-in-service year to revoke the election, provided the 
taxpayer timely filed its Federal tax return for the placed-in-service 
year.

Liberty Zone Property

    Generally, the requirements for determining the eligibility of 
property for the additional first year depreciation deduction for 
Liberty Zone property provided by section 1400L(b) are similar to the 
requirements for the 30-percent additional first year depreciation 
deduction for qualified property provided by section 168(k)(1) in the 
final regulations. The final regulations made several changes to the 
temporary regulations with respect to the Liberty Zone property, which 
are discussed below.
    The final regulations retain the rule contained in the temporary 
regulations providing that Liberty Zone property includes the same 
property that is described as qualified property or 50-percent bonus 
depreciation property for purposes of section 168(k). In addition, 
Liberty Zone property includes nonresidential real property or 
residential rental property to the extent such property rehabilitates 
real property damaged, or replaces real property destroyed or 
condemned, as a result of the terrorist attacks of September 11, 2001. 
Real property is considered to have been destroyed or condemned only if 
an entire building or structure was destroyed or condemned as a result 
of the terrorist attacks of September 11, 2001. Property is treated as 
replacing destroyed or condemned property if, as part of an integrated 
plan, the property replaces real property that is included in a 
continuous area that includes real property destroyed or condemned. A 
commentator noted that the temporary regulations simply reiterate the 
statute but do not define the word continuous. The IRS and Treasury 
Department believe that the common meaning of continuous applies.
    The temporary regulations define real property as a building or its 
structural components, or other tangible real property except: (1) 
Property described in section 1245(a)(3)(B) (relating to depreciable 
property used as an integral part of a specified activity or as a 
specified facility); (2) property described in section 1245(a)(3)(D) 
(relating to a single purpose agricultural or horticultural structure); 
and (3) property described in section 1245(a)(3)(E) (relating to 
storage facility used in connection with the distribution of petroleum 
or any primary product of petroleum). A commentator suggested that 
these exclusions to the definition of real property should be deleted 
in the final regulations. As a result of this definition, 
nonresidential real property or residential rental property that 
rehabilitates or replaces any of the excluded properties that were 
damaged, destroyed, or condemned, is not eligible for the Liberty Zone 
additional first year depreciation deduction. For this reason, the IRS 
and Treasury Department agree. Accordingly, the final regulations 
provide that real property is a building or its structural components, 
or other tangible real property.
    The temporary regulations provide that Liberty Zone property does 
not include property that is described as qualified property or 50-
percent bonus depreciation property for purposes of section 168(k), or 
property that is described in Sec.  1.168(k)-1T(b)(2)(ii). The property 
described in Sec.  1.168(k)-1T(b)(2)(ii) is property that is: (1) 
Described in section 168(f); (2) required to be depreciated under the 
alternative depreciation system; (3) included in any class of property 
for which the taxpayer elects out of the additional first year 
depreciation deduction under section 168(k); or (4) qualified Liberty 
Zone leasehold improvement property. Instead of providing a cross-
reference to Sec.  1.168(k)-1(b)(2)(ii), the final regulations list the 
property that is described in Sec.  1.168(k)-1(b)(2)(ii) with one 
modification to the exclusion for property that is included in any 
class of property for which the taxpayer elects out of the additional 
first year depreciation deduction under section 168(k). In this regard, 
a commentator stated that while section 1400L(b)(2)(C)(iv) provides 
that the election out rules for purposes of section 1400L(b) are to be 
similar to the election out rules under section 168(k), section 
1400L(b)(2)(C)(iv) does not mean

[[Page 51733]]

that the same election must be made with respect to both sections 
168(k) and 1400L(b). Accordingly, the commentator suggested that a 
taxpayer be permitted to elect not to apply section 168(k) to its 
property of a particular class of property to the extent that such 
property is not located within the Liberty Zone, while still being 
entitled to the benefits of section 1400L(b) for its property of the 
same class that is located within the Liberty Zone. The IRS and 
Treasury Department agree with this suggestion. Accordingly, the final 
regulations make clear that Liberty Zone property is not property 
included in any class of property for which the taxpayer elects out of 
the additional first year depreciation deduction under section 
1400L(b).
    The final regulations retain the rule contained in the temporary 
regulations providing that Liberty Zone property is property that is 
acquired by the taxpayer by purchase after September 10, 2001, but only 
if no written binding contract for the acquisition of the property was 
in effect before September 10, 2001. The term by purchase is defined in 
section 179(d) and Sec.  1.179-4(c). The final regulations also retain 
the rule contained in the temporary regulations providing that the new 
partnership resulting from a technical termination under section 
708(b)(1)(B) or a transferee in section 168(i)(7) transactions is 
deemed to acquire the depreciable property by purchase. A commentator 
suggested that the rule should apply only if the old transferor 
partnership had itself acquired the property by purchase, as the mere 
existence of a technical termination does not provide sufficient reason 
to deem the statutory purchase requirement to have been met. The final 
regulations do not adopt this suggestion. The rule is the result of the 
rules provided in the temporary regulations regarding the additional 
first year depreciation deduction under sections 168(k) and 1400L(b) 
that allow the new partnership resulting from a technical termination 
to be entitled to the additional first year depreciation deduction for 
eligible property that was placed in service by the terminated 
partnership during the taxable year of termination. As a result, the 
IRS and Treasury Department determined that the rule should not be 
changed.
    The final regulations also retain the rules contained in the 
temporary regulations for electing not to deduct the Liberty Zone 
additional first year depreciation deduction for a class of property. 
In addition, the final regulations for this election include provisions 
similar to those previously discussed relating to the alternative 
minimum tax and the revocation of the election with respect to the 
election not to deduct the additional first year depreciation deduction 
under section 168(k).

Special Rules

    Similar to the temporary regulations, the final regulations provide 
special rules for the following situations: (1) Qualified property, 50-
percent bonus depreciation property, or Liberty Zone property placed in 
service and disposed of in the same taxable year; (2) redetermination 
of basis of qualified property, 50-percent bonus depreciation property, 
or Liberty Zone property; (3) recapture of additional first year 
depreciation for purposes of section 1245 and section 1250; (4) a 
certified pollution control facility that is qualified property, 50-
percent bonus depreciation property, or Liberty Zone property; (5) 
like-kind exchanges and involuntary conversions of qualified property, 
50-percent bonus depreciation property, or Liberty Zone property; (6) a 
change in use of qualified property, 50-percent bonus depreciation 
property, or Liberty Zone property; (7) the computation of earnings and 
profits; (8) the increase in the limitation of the amount of 
depreciation for passenger automobiles; and (9) the step-up in basis 
due to a section 754 election. For some of these situations, the final 
regulations modify or clarify the rules contained in the temporary 
regulations. In addition, the final regulations provide rules for two 
new situations: the rehabilitation credit under section 47 and the 
computation of depreciation for purposes of section 514(a)(3).

Property Placed in Service and Disposed of in the Same Taxable Year

    With respect to qualified property, 50-percent bonus depreciation 
property, or Liberty Zone property placed in service and disposed of in 
the same taxable year, the final regulations retain the rules contained 
in the temporary regulations. In general, the regulations provide that 
the additional first year depreciation deduction is not allowed. If 
qualified property or 50-percent bonus depreciation property is placed 
in service and disposed of by a taxpayer in the same taxable year and 
then, in a subsequent taxable year, is reacquired and again placed in 
service by the taxpayer, a commentator inquired whether the additional 
first year depreciation deduction is allowable in the subsequent 
taxable year. Because the property is used property in the subsequent 
taxable year, the additional first year depreciation deduction is not 
allowable for the property in the subsequent taxable year. Accordingly, 
in this situation, the final regulations clarify that the additional 
first year depreciation deduction is not allowable for the property in 
the subsequent taxable year.
    The temporary regulations provide two exceptions to the general 
rule. First, the additional first year depreciation deduction is 
allowable for qualified property, 50-percent bonus depreciation 
property, or Liberty Zone property placed in service by a terminated 
partnership in the same taxable year in which a technical termination 
of the partnership occurs. In this case, the new partnership, and not 
the terminated partnership, claims the additional first year 
depreciation deduction. Second, the additional first year depreciation 
deduction is allowable for qualified property, 50-percent bonus 
depreciation property, or Liberty Zone property placed in service by a 
transferor in the same taxable year in which the property is 
transferred in a transaction described in section 168(i)(7). In this 
case, the additional first year depreciation deduction for the 
transferor's taxable year in which the property is placed in service is 
allocated between the transferor and the transferee on a monthly basis. 
The allocation shall be made in accordance with the rules in Sec.  
1.168(d)-1(b)(7)(ii) for allocating the depreciation deduction between 
the transferor and the transferee. If the transferee has a different 
taxable year than the transferor, a commentator questioned whether the 
allocation of the additional first year depreciation deduction would be 
made between the transferor and the transferee in accordance with the 
above rules. Because the allocation rules in Sec.  1.168(d)-1(b)(7)(ii) 
cover this situation, the IRS and Treasury Department did not modify 
the rule in the final regulations.

Redetermination of Basis

    The final regulations also retain the rules contained in the 
temporary regulations with respect to a redetermination of basis of 
qualified property, 50-percent bonus depreciation property, or Liberty 
Zone property (for example, due to a contingent purchase price or a 
discharge of indebtedness). These rules apply to a redetermination of 
the unadjusted depreciable basis of the property occurring before 
January 1, 2005 (January 1, 2006, for the extended placed-in-service 
date property) for qualified property or 50-percent bonus depreciation 
property, or before January 1, 2007 (January 1, 2010, in the case of 
nonresidential real property and

[[Page 51734]]

residential rental property) for Liberty Zone property. A commentator 
suggested that the rules should be expanded to include redeterminations 
of basis occurring on or after these dates. The commentator pointed out 
that the rule results in additional first year depreciation not being 
allowable for additional purchase price paid on or after January 1, 
2005, with respect to qualified property or 50-percent bonus 
depreciation property acquired before 2005. The final regulations do 
not adopt this suggestion. While the current rule may be unfavorable 
when, for example, a redetermination of basis results in an increase of 
basis on or after January 1, 2005, for qualified property or 50-percent 
bonus depreciation property acquired before 2005, the current rule may 
be favorable when, for example, a redetermination of basis results in a 
decrease of basis on or after January 1, 2005, with respect to 
qualified property or 50-percent bonus depreciation property acquired 
before 2005. Further, the IRS and Treasury Department limited the rules 
to redeterminations occurring before the dates mentioned above to be 
consistent with the dates on which property must be placed in service 
to be eligible for the additional first year depreciation deduction. 
For this reason, the IRS and Treasury Department determined not to 
change the rule in the final regulations.
    In the case of a redetermination of basis that results in a 
decrease in basis, a commentator noted that the operative rule provides 
that the taxpayer includes in the taxpayer's income the excess 
additional first year depreciation deduction previously claimed for the 
qualified property, the 50-percent bonus depreciation property, or the 
Liberty Zone property but the example illustrating the application of 
this rule allows the taxpayer to reduce current year depreciation 
deductions by the amount of the excess additional first year 
depreciation deduction previously claimed for the qualified property, 
the 50-percent bonus depreciation property, or Liberty Zone property. 
Because the IRS and Treasury Department recognize that the lump-sum 
inclusion in income approach provided in the operative rule of the 
temporary regulation may adversely affect real estate investment trusts 
and similar entities, the final regulations provide that the excess 
additional first year depreciation deduction offsets the amount 
otherwise allowable for depreciation for the taxable year. Even if the 
amount of the offset exceeds the amount otherwise allowable for 
depreciation for the taxable year, the taxpayer takes into account a 
negative depreciation deduction in computing taxable income.
    The final regulations retain the rule contained in the temporary 
regulations providing that, for purposes of the redetermination of 
basis rules: (1) an increase in basis occurs in the taxable year an 
amount is taken into account under section 461; and (2) a decrease in 
basis occurs in the taxable year an amount is taken into account under 
section 451. A commentator questioned whether because the event in 
question is giving rise to a basis adjustment, rather than to an item 
of income or deduction, it is appropriate for the rule to tie the 
timing of the adjustment to accounting method rules concerning the 
timing of income and deductions. The commentator also noted that one 
apparent effect of applying the accounting method rules is to override 
the basis reduction rule of section 1017(a) as illustrated in Example 2 
of Sec.  1.168(k)-1T(f)(2)(iv). The IRS and Treasury Department did not 
intend to change the section 1017(a) rules. While the IRS and Treasury 
Department continue to believe that the current rule is appropriate, 
the final regulations have been modified for cases in which the Code, 
the regulations under the Code, or other published guidance expressly 
provides an exception to such rule (for example, section 1017(a)). 
Therefore, Example 2 of Sec.  1.168(k)-1(f)(2)(iv) in the final 
regulations reflects the basis adjustment rules of section 1017(a).

Like-Kind Exchanges and Involuntary Conversions

    With respect to MACRS property or computer software acquired in a 
like-kind exchange under section 1031 or as a result of an involuntary 
conversion under section 1033, the final regulations change the rules 
contained in the temporary regulations (TD 9091 as amended by TD 9115) 
in several respects. First, the final regulations modify the scope of 
this provision to include property described in section 168(k)(2)(C) 
(certain aircraft), which was added to section 168(k) by section 336 of 
the AJCA, and to include property to which Announcement 2006-29 (2006-
19 IRB 879) applies if the time of replacement is after September 10, 
2001, and before January 1, 2007. As previously noted, Announcement 
2006-29 applies to property described in section 168(k)(2)(B) or (C) 
that is either placed in service by the taxpayer or manufactured by a 
person in the Gulf Opportunity (GO) Zone, the Rita GO Zone, or the 
Wilma GO Zone, provided the taxpayer was unable to meet the December 
31, 2005, placed-in-service date deadline for such property as a result 
of Hurricane Katrina, Hurricane Rita, or Hurricane Wilma. Similar 
changes also are made to the paragraph relating to the computation of 
the additional first year depreciation deduction for MACRS property or 
computer software acquired in a like-kind exchange or as a result of an 
involuntary conversion.
    A commentator inquired whether the rules should be expanded to 
include exchanged or involuntarily converted property that is subject 
to former section 168 (the accelerated cost recovery system or ACRS) or 
that is pre-1981 depreciation property. The current rules apply only to 
exchanged or involuntarily converted property that is MACRS property in 
order to conform with Sec.  1.168(i)-6T (relating to depreciation of 
property acquired in like-kind exchanges or as a result of involuntary 
conversions). Accordingly, the IRS and Treasury Department believe that 
this issue is outside the scope of these regulations and should be 
addressed when the temporary regulations under Sec.  1.168(i)-6T are 
finalized.
    Second, the temporary regulations define the time of replacement as 
the later of when the acquired MACRS property or acquired computer 
software is placed in service, or the time of disposition of the 
exchanged or involuntarily converted property. A commentator expressed 
concern that in the case of an involuntary conversion under section 
1033, the final regulations may confer an unintended benefit in the 
case of taxpayers who acquired property prior to September 11, 2001, in 
order to replace property that was ultimately requisitioned or 
condemned after September 10, 2001, but as to which the threat or 
imminence of condemnation existed prior to that date. The IRS and 
Treasury Department acknowledge that the rule confers a benefit under 
such circumstances, but continue to believe that the rule is 
appropriate. Additionally, the IRS and Treasury Department decided to 
provide rules in the final regulations to address how the additional 
first year depreciation deduction is treated when Sec.  1.168(i)-
6T(d)(4) applies. Section 1.168(i)-6T(d)(4) applies when, in an 
involuntary conversion, a taxpayer acquires and places in service 
acquired MACRS property before the time of disposition of the 
involuntarily converted MACRS property. If the time of disposition of 
the involuntarily converted MACRS property is after December 31, 2004, 
or, in the case of property described in section 168(k)(2)(B) or (C), 
after December 31, 2005 (or after December 31, 2006, in the

[[Page 51735]]

case of property described in section 168(k)(2)(B) or (C) to which 
Announcement 2006-29 applies), the final regulations provide that the 
time of replacement is when the acquired MACRS property is placed in 
service, provided the threat or imminence of requisition or 
condemnation of the converted property existed prior to January 1, 
2005, or, in the case of property described in section 168(k)(2)(B) or 
(C), existed before January 1, 2006 (or existed before January 1, 2007, 
in the case of property described in section 168(k)(2)(B) or (C) to 
which Announcement 2006-29 applies). In this case, the final 
regulations also modify the income inclusion rule in Sec.  1.168(i)-
6T(d)(4) to allow the additional first year depreciation deduction on 
the remaining carryover basis of the acquired MACRS property that is 
qualified property, 50-percent bonus depreciation property, or Liberty 
Zone property.
    Third, the final regulations clarify the rules contained in the 
temporary regulations relating to the computation of the additional 
first year depreciation deduction for property described in section 
168(k)(2)(B) (longer production period property) and for alternative 
minimum tax purposes. In both cases, the temporary regulations provide 
a cross-reference to Sec.  1.168(k)-1T(d) (computation of depreciation 
deduction for qualified property or 50-percent bonus depreciation 
property). A commentator suggested that the purpose of the reference to 
Sec.  1.168(k)-1T(d) should be clarified. The final regulations adopt 
this suggestion by deleting the cross-reference and providing rules for 
computing the additional first year depreciation deduction for property 
described in section 168(k)(2)(B) (longer production period property) 
and for alternative minimum tax purposes.
    Also, a commentator questioned whether the rule that the additional 
first year depreciation is calculated separately with respect to the 
carryover basis and the excess basis is appropriate, and suggested that 
the rule should be simplified by eliminating the requirement of 
separate calculations. The IRS and Treasury Department believe that the 
rule is appropriate because it conforms with Sec.  1.168(i)-6T, which 
requires separate calculations of depreciation for the carryover basis 
and the excess basis.
    Fourth, the final regulations clarify the rules contained in the 
temporary regulations relating to exchanged or involuntarily converted 
MACRS property or exchanged or involuntarily converted computer 
software that is placed in service and disposed of in an exchange or 
involuntary conversion in the same taxable year. In this case, the 
temporary regulations provide that the additional first year 
depreciation deduction is not allowable for the exchanged or 
involuntarily converted MACRS property or the exchanged or 
involuntarily converted computer software if the MACRS property or 
computer software is placed in service and disposed of in an exchange 
or involuntary conversion in the same taxable year. A commentator 
suggested that the final regulations clarify that the reference in the 
above rule to the MACRS property or computer software that is placed in 
service and disposed of in the same taxable year is the exchanged or 
involuntarily converted MACRS property or exchanged or involuntarily 
converted computer software. The final regulations adopt this 
suggestion.
    Finally, a new example is added and the facts in several of the 
examples are clarified to reflect that the acquired property must be 
new property in order to meet the original use requirement and, 
therefore, qualify for the additional first year depreciation 
deduction.

Change in Use

    The final regulations retain the rules contained in the temporary 
regulations providing when the use of qualified property, 50-percent 
bonus depreciation property, or Liberty Zone property changes in the 
hands of the same taxpayer during the placed-in-service year or a 
subsequent taxable year. One of these rules provide that if property is 
acquired by a taxpayer for personal use and, during a subsequent 
taxable year, is converted by the taxpayer from personal use to 
business or income-producing use, the additional first year 
depreciation deduction is allowable for the property in the taxable 
year the property is converted to business or income-producing use 
(assuming all the requirements for the additional first year 
depreciation deduction are met). Another rule provides that if 
depreciable property is not qualified property, 50-percent bonus 
depreciation property, or Liberty Zone property in the placed-in-
service year, the additional first year depreciation deduction is not 
allowable for the property even if a change in the use of the property 
subsequent to the placed-in-service year results in the property being 
qualified property, 50-percent bonus depreciation property, or Liberty 
Zone property in the taxable year of the change in use. A commentator 
questioned whether these two rules are inconsistent. The commentator 
further noted that under Sec.  1.167(a)-11(e)(1)(i), property that is 
ready for use in a personal activity is considered to be placed in 
service. The IRS and Treasury Department do not believe that the two 
rules are inconsistent. Property is eligible for the additional first 
year depreciation deduction if in the first year in which the property 
is subject to depreciation, the property meets all the requirements to 
qualify for the additional first year depreciation deduction. In the 
case of property that changes from personal use to a business or 
income-producing use, the first year such property is subject to 
depreciation is the year of conversion to business or income-producing 
use. But in the case of property that changes from a depreciable use 
not eligible for the additional first year depreciation deduction to a 
depreciable use that is eligible for the additional first year 
depreciation deduction, such property did not meet the requirements to 
qualify for the additional first year depreciation deduction in the 
first year in which the property is subject to depreciation.

Earnings and Profits

    The final regulations retain the rule contained in the temporary 
regulations providing that the additional first year depreciation 
deduction is not allowable for purposes of computing earnings and 
profits. A commentator suggested that because this provision interprets 
section 312(k), the regulations under section 312 should include a 
cross-reference to the regulations under section 168(k). The IRS and 
Treasury Department agree and, accordingly, the final regulations adopt 
this suggestion.

280F(a)(1) Limitation

    The final regulations also retain the rules contained in the 
temporary regulations providing the increase in the limitation under 
section 280F(a)(1) of the amount of depreciation for certain passenger 
automobiles that are qualified property or 50-percent bonus 
depreciation property. A commentator had three inquiries about this 
increase in the limitation under section 280F(a)(1). First, the 
commentator asked whether the increase in the limitation can be taken 
as a section 179 expense. The increase in the limitation under section 
280F(a)(1) that is provided in the final regulations may be taken as a 
section 179 expense. Second, the commentator asked whether the increase 
in the limitation of amount of depreciation for certain passenger 
automobiles needs to be prorated in a short taxable year. Because the 
additional first year depreciation

[[Page 51736]]

deduction is not prorated for a short taxable year, the increase in the 
limitation under section 280F(a)(1) that is provided in the final 
regulations also is not prorated. Third, when calculating depreciation 
for an asset with less than 100 percent business use, the commentator 
asked whether the business use percentage is applied to the increase in 
the limitation of amount of depreciation for certain passenger 
automobiles. If a taxpayer's business use of the automobile is less 
than 100 percent, the business use percentage is applied to the 
automobile's depreciation deduction, including the additional first 
year depreciation deduction, for the taxable year. The IRS and Treasury 
Department believe that these issues are outside the scope of these 
regulations and, accordingly, the final regulations do not address 
these issues.

Section 754 Election

    Finally, the final regulations retain the rules contained in the 
temporary regulations relating to any increase in basis of qualified 
property, 50-percent bonus depreciation property, or Liberty Zone 
property due to a section 754 election. Under these rules, such 
increase in basis generally is not eligible for the additional first 
year depreciation deduction. However, if qualified property, 50-percent 
bonus depreciation property, or Liberty Zone property is placed in 
service by a partnership in the taxable year the partnership terminates 
under section 708(b)(1)(B), any increase of basis of the qualified 
property, 50-percent bonus depreciation property, or Liberty Zone 
property due to a section 754 election is eligible for the additional 
first year depreciation deduction. A commentator requested that we 
expand this terminating partnership rule to any increase in basis due 
to a section 754 election that arises before or during the placed-in-
service year of the property. The IRS and Treasury Department decided 
not to do so. The rule for a termination of a partnership under section 
708(b)(1)(B) was made to be consistent with the special rule allowing 
the new partnership, instead of the terminated partnership, to claim 
the additional first year depreciation deduction for property placed in 
service during the taxable year of termination and contributed by the 
terminated partnership to a new partnership. The IRS and Treasury 
Department believe that these rules should