Property under ‘turn-key’ contract eligible for bonus depreciation

The IRS released Field Attorney Advice (FAA 20234801F) determining that under the terms of a turn-key construction contract, the taxpayer met the acquisition date requirements for bonus depreciation after analyzing the 10% safe harbor rule for determining when physical work of a significant nature began under a binding written contract.  

The FAA redacts certain key dates about the contract (e.g., the date on which the contract was signed or binding) and about the property (e.g., the type or property class) but it appears based on the analysis that the property was placed in service after Sept. 27, 2017, subject to a written binding contract executed prior to Sept. 28, 2017, and Phase 1 was likely more than 10% complete prior to Sept. 28, 2017.

Because 100% bonus depreciation was only made available for property both acquired and placed in service after Sep. 27, 2017, the ruling hinged on whether the property was considered “acquired” after Sept. 27, 2017 under Treas. Reg. Sec. 1.168(k)-2(b)(5).

Under the regulations, property is generally considered to be acquired when a taxpayer enters into a written binding contract. Treas. Reg. Sec. 1.168(k)-2(b)(5)(iv) further provides that in the case of property that is manufactured, constructed or produced for the taxpayer by another party, pursuant to a written binding contract, the acquisition date requirement is met when physical work of a significant nature begins. To determine when physical work of a significant nature begins, a taxpayer may elect to use the 10% safe harbor. For an accrual basis taxpayer, the safe harbor rule means that the acquisition date is considered to be when a taxpayer incurs more than 10% of the total cost of property, excluding the cost of land and preliminary activities, such as designing, financing, exploring or researching.

Section 461(h) and the regulations thereunder provide that a liability is not incurred until economic performance occurs. Treas. Reg. Sec. 1.461-4(d)(2) provides that for an accrual method taxpayer, economic performance for liabilities related to the provision of property generally occurs as the property is provided by the other party to the taxpayer. Treas. Reg. Sec. 1.461-4(6)(iii) allows a taxpayer to treat property as provided when the property is delivered or accepted, or when title passes.

The taxpayer addressed by the guidance was a partnership for federal income tax purposes using the accrual method of accounting, and executed an engineering, procurement and construction (EPC) contract with an unrelated third-party contractor To construct a facility for use in the taxpayer’s trade or business. The construction contract was a “turn-key” contract, which required the contractor to design; construct; inspect and test a facility integrate it with the existing property, prepare the worksite and construct utilities and infrastructure, procure all supplies and permits, and all other acts to ensure that the facility was fully functional and operational for the taxpayer.

The contract was designed to be completed in three phases. Once certain specified conditions were satisfied with respect to a particular phase for example that the property was ready for start-up and the taxpayer’s personnel had completed required training, the parties would execute a substantial completion contract and the care, custody and control of the equipment and facilities would pass to the taxpayer. For purposes of Treas. Reg. Sec. 1.461-1(d)(6)(iii) the taxpayer had adopted a method of accounting that treats property as provided to the taxpayer when the property is accepted by the taxpayer. Upon substantial completion of the first phase, the taxpayer accepted the property and placed it into service in its trade or business.

As described above, the taxpayer represented that it had adopted and consistently used a method of accounting that treats property as provided when the property is accepted. Under the turn-key contract, the taxpayer did not accept the property until it signed the substantial completion certificate for each phase of the construction project. The IRS agreed that based on the terms of the contract and its method of accounting, economic performance for the contract did not occur until the taxpayer accepted the property by signing the substantial completion certificate for each phase. Accordingly, the liability was not incurred until acceptance and the acquisition date of the property, including an application of the 10% rule, was the date on which the property was accepted. That date was after Sept. 27, 2017, so the IRS concluded that the property was eligible for the 100% bonus depreciation deduction.