IRC 168(k)(7): Limitations on Bonus Depreciation

Internal Revenue Code (IRC) Section 168(k) provides for bonus depreciation, which permits businesses to immediately deduct a percentage of the cost of qualifying business assets. The 100% bonus depreciation rate established by the Tax Cuts and Jobs Act of 2017 (TCJA) is phasing down, and for property placed in service in 2025, the rate is 40%. A change introduced by the TCJA was the removal of the “original use” rule, extending this benefit to include used property.

To prevent misuse of this expanded provision, Congress enacted anti-churning rules. The purpose of these regulations is to stop taxpayers from claiming the deduction on assets they or a related entity already had a depreciable interest in. This prevents “churning” assets to generate a tax benefit without a genuine change in economic ownership.

General Requirements for Used Property Bonus Depreciation

Before the specific disqualifications of the anti-churning rules are considered, a business must first ensure the used property meets several baseline criteria to be eligible for bonus depreciation.

• The taxpayer, or a predecessor entity, cannot have used the property at any time before acquiring it.
• The asset must be Modified Accelerated Cost Recovery System (MACRS) property with a recovery period of 20 years or less, which includes assets like equipment, machinery, furniture, and certain computer software.
• The acquisition must conform to the rules for property acquired by purchase, as outlined in Section 179.
• The property must have been acquired after September 27, 2017, and not from a related party.

The Related Party Disqualification

A central part of the anti-churning rules is the prohibition against acquiring property from a related party. This rule is designed to prevent taxpayers from generating artificial depreciation deductions by simply moving assets between controlled entities or family members. The definition of a “related party” is tied to the relationships detailed in IRC Sections 267 and 707, which cover a broad spectrum of common business and family structures.

For instance, under Section 267, transactions between an individual and their family members—including spouses, children, grandchildren, parents, and siblings—are disallowed. It also applies to transactions between an individual and a corporation where that individual owns more than 50% of the stock. Section 707 extends these principles to partnerships, disallowing transactions between a partnership and a person owning more than 50% of the capital or profits interest, or between two partnerships in which the same persons own more than 50% of the interests.

For example, if a business owner operating as a sole proprietorship forms a new S-corporation and sells equipment to it, the corporation cannot claim bonus depreciation on that equipment. In contrast, if that same S-corporation purchases identical equipment from an unaffiliated, third-party vendor, the acquisition would clear this hurdle, making the assets potentially eligible for bonus depreciation.

Rules for Predecessors and Consolidated Groups

The anti-churning provisions extend beyond simple related party transactions to address predecessors and consolidated corporate groups. The “predecessor” rule is designed to prevent a taxpayer from claiming bonus depreciation on an asset that the taxpayer or a prior entity, whose tax attributes carry over, has already used. A predecessor is typically established in certain tax-free transactions, such as corporate reorganizations under Section 368 or tax-free liquidations under Section 332.

In these scenarios, the acquiring entity is treated as a continuation of the old one for purposes of the asset’s use history. A distinct but related rule applies to corporations that file a consolidated tax return as a single group. If one member of a consolidated group acquires property from another member of the same group, that property is ineligible for bonus depreciation because the group is treated as a single taxpayer.

Considerations for Asset Acquisitions

When a business is considering purchasing the assets of another business, the ability to claim bonus depreciation on the acquired used property can be a significant financial factor. Applying the anti-churning rules requires careful due diligence on the part of the buyer to confirm the eligibility of the assets before the transaction is finalized.

The buyer must first determine if the seller qualifies as a related party. This involves analyzing the ownership structures of both the buying and selling entities to identify any overlapping control or familial relationships that would trigger the disqualification.

Another inquiry is whether the buyer, or any entity considered its predecessor, has previously owned and used the specific assets being acquired. The buyer should obtain confirmation from the seller regarding the asset’s history, a representation that is often included in the asset purchase agreement.