GO Zone Bonus Depreciation Extended

On Dec. 20, 2006, President Bush signed into law the Tax Relief and Health Care Act of 2006 (TRAHCA ’06). This much-anticipated legislation extended a slate of 23 tax provisions that expired at the end of 2005 or were set to expire in the near future, including the research and experimentation tax credit, the welfare-to-work credit and the new markets tax credit. (The research credit is discussed in Arkin and Goldbas, Tax Clinic, “Enhanced Research Credit for 2007,” in this issue.) Included is a provision extending the placed-in-service date for taxpayers claiming 50% additional first-year bonus depreciation for certain qualified Gulf Opportunity Zone (GO Zone) property. However, the extension applies only to “specified Gulf Opportunity Zone extension property,” a subset of otherwise-qualifying GO Zone property.

The “Gulf Opportunity Zone” is defined as that portion of the Hurricane Katrina Disaster Area determined to warrant individual and/or public assistance from the Federal government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act. “Hurricane Katrina disaster area” means an area with respect to which a major disaster was declared by the President before Sept. 14, 2005, under Section 401 of that Act.

GO Zone Act Revisited

Almost exactly one year before the enactment of the TRAHCA ’06, President Bush signed into law the Gulf Opportunity Zone Act of 2005 (GO Zone Act). It provided tax relief to businesses to encourage redevelopment and capital expansion within the Gulf region affected by Hurricanes Rita, Wilma and Katrina. One of the most popular and widely applicable incentives was a provision for additional first-year depreciation of 50% of the adjusted basis of qualified GO Zone property. To qualify for bonus depreciation, property must meet each of the following six criteria:

1. It must be one of the following types of depreciable property:

• Modified accelerated cost recovery system (MACRS) property with a 20-year-or-less recovery period;

• Computer software (as defined in Sec. 167(f)(1)(B)) depreciable under Sec. 167(a);

• Water utility property;

• Qualified leasehold improvement property;

• Nonresidential real property;

• Residential rental property.

2. Substantially all of the property’s use (80% or more during each tax year) must be in the GO Zone.

3. The property must be used in the active conduct of a trade or business by the taxpayer in the GO Zone; property held merely for the production of income or used in an activity not engaged in for profit does not qualify.

4.  Original use must start with the taxpayer in the GO Zone on or after Aug. 27, 2005. Rules similar to the original-use rules in Regs. Sec. 1.168(k)-1(b)(3) apply. Used property will meet the original-use requirement if the property has not been previously used within the GO Zone.

5. The property must be acquired by the taxpayer by purchase (as defined in Sec. 179(d) and Regs. Sec. 1.179-4(c)) after Aug. 27, 2005, but only if no written binding contract for the property’s acquisition was in effect before Aug. 28, 2005. The rules in Regs. Sec. 1.168(k)-1(b)(4)(ii) (binding contract), rules similar to those in Regs. Sec. 1.168(k)-1(b)(4)(iii) (self-constructed property) and rules similar to those in Regs. Sec. 1.168(k)-1(b)(iv) (disqualified transactions) apply.

6. The property must be placed in service before 2008 (2009 for nonresidential real property and residential rental property).

Even if each of these criteria is met, several types of property are specifically excluded from GO Zone bonus depreciation, including property used in certain “sin” businesses (see Sec. 1400N(p)(3)), tax-exempt use property and property financed with the proceeds of an exempt obligation. Finally, recapture rules apply if property ceases to be qualified GO Zone property before fully depreciated.

The big news from the GO Zone Act was the ability to recover up to 50% of the cost of capitalized real estate development expenditures in the year the applicable property was placed in service (rather than recovering such costs straight-line over a 27.5- or 39-year term). This accelerated cost recovery provided tremendous incentive for real estate developers and corporations to consider both redevelopment and commercial/residential expansion in the applicable Gulf region. However, with much work still left to do to rebuild that region and the deadline for placed-in-service dates on the horizon (2007 and 2008), developers, community development organizations and corporations sought an extension of the GO Zone bonus-depreciation rules. Congress granted this relief, but only to the extent that property meets a new definition—“specified Gulf Opportunity Zone extension property.”

Specified Gulf Opportunity Zone Extension Property

TRAHCA ’06 Section 120 defines “specified Gulf Opportunity Zone extension property” as

property—substantially all of the use of which is in one or more specified portions of the GO Zone, and which is—(I) nonresidential real property or residential rental property which is placed in service by the taxpayer on or before Dec. 31, 2010, or (II) in the case of a taxpayer who places a building described in subclause (I) in service on or before Dec. 31, 2010, property described in section 168(k)(2)(A)(i) if substantially all of the use of such property is in such building and such property is placed in service by the taxpayer not later than 90 days after such building is placed in service.

This difficult definition basically limits the type of qualifying GO Zone property to primarily nonresidential real and residential rental property (e.g., buildings) placed in service within “specified portions of the GO Zone” before 2011 (however, see the bifurcated adjusted-basis-limit discussion below). In addition, MACRS personal property with a recovery period of 20 years or less, placed into service within 90 days of the associated building, will also qualify for 50% additional first-year bonus depreciation, provided such property is also substantially used in the building.

As a practical matter, this rule will exclude certain transportation and distribution property (trucks, trailers, etc.) from qualifying for the extension of GO Zone bonus depreciation, as this and other property used 21% or more outside the building will not qualify.

Bifurcated Adjusted-Basis Limit

The statute provides a further limit, allowing 50% first-year bonus depreciation to be claimed on nonresidential real and residential rental property only to the extent the property’s adjusted basis is attributable to manufacture, construction or production occurring before 2010. Thus, although the period to place qualifying real estate into service is before 2010, only “progress expenditures” incurred through the end of 2009 qualify for specified extension GO Zone bonus depreciation. This may cause some complexity in accounting for bonus depreciation for property placed in service in 2010; taxpayers will be required to bifurcate adjusted basis between expenditures incurred before 2010 and those incurred thereafter.

Interestingly, this same bifurcation rule does not apply for personal property with a MACRS recovery period of less than 20 years. This property will continue to qualify for 50% additional first-year bonus depreciation of the full adjusted basis, if the property meets the 90-day and “substantially all the use in the building” requirements. Essentially, taxpayers will be able to claim GO Zone bonus depreciation on certain personal property placed in service all the way through March 30, 2011 (if used in a building placed in service before 2011).  

Specified Portion of the GO Zone

For purposes of determining which counties and parishes within Louisiana, Mississippi and Alabama qualify for the extended placed-in-service dates, TRAHCA ’06 Section 120(a) defines “specified portion of the GO Zone” to mean “those portions of the GO Zone which are in any county or parish which is identified by the Secretary as being a county or parish in which hurricanes occurring during 2005 damaged (in the aggregate) more than 60 percent of the housing units in such county or parish which were occupied (determined according to the 2000 Census).”

The qualifying counties and parishes will be identified using an analysis published Feb. 12, 2006 by the Office of the Federal Coordinator for Gulf Coast Rebuilding at the Department of Homeland Security (Federal coordinator analysis), in cooperation with the Federal Emergency Management Agency, the Small Business Administration and the Department of Housing and Urban Development (see Joint Committee on Taxation, Technical Explanation Of H.R. 6408, The “Tax Relief And Health Care Act Of 2006,” As Introduced in the House on December 7, 2006 (JCX-50-06, 12/7/06), p. 40, fn. 52).

A review of this analysis identifies seven Louisiana parishes and five Mississippi counties as meeting the “60% occupied units with damage” requirement. (Note: until Treasury formally identifies and publishes authoritative guidance, no counties or parishes actually qualify. However, the counties and parishes listed in the exhibit  are likely candidates for designation as the “specified portion of the GO Zone,” based on the Federal coordinator analysis.)

Summary

The exhibit compares the key requirements for qualifying for both GO Zone bonus depreciation, as well as the specified GO Zone extension property bonus depreciation.

From Gary Hecimovich, CPA, and Scott Mackay, CPA, Washington, DC