Used Property and Bonus Depreciation Eligibility

Most rental properties are bought from prior owners, so it is important to know whether components inside a previously owned building can qualify for bonus depreciation. The general answer under the rules as understood is that used property can qualify under certain conditions. This page explains the conditions in general terms. Verify with your preparer.

The concept

Historically, bonus depreciation applied only to new property. Legislation in 2017 extended it to used property, subject to conditions designed to prevent it from applying to property that the taxpayer or related parties already used. That matters for buildings bought from third parties because the components inside, such as carpeting or fixtures, were used by the seller.

General conditions, in plain terms

Without providing an exhaustive list, the conditions generally look at whether:

• The property was not previously used by the taxpayer or a predecessor in a disqualifying way.
• The property was acquired by purchase from an unrelated party.
• The basis of the property is not determined by reference to the seller's basis, as it would be in certain non-taxable exchanges or gifts.

These conditions raise questions in certain transactions, such as purchases from relatives, acquisitions between related entities, and property received in some corporate or partnership transactions. Ask your preparer to review your transaction.

A typical purchase from an unrelated seller

An ordinary purchase from an unrelated seller often satisfies the acquisition conditions, though each fact pattern requires review. That is a large part of why cost segregation is widely used for acquired buildings.

Related-party and exchange situations

Purchases from family members, transfers between commonly owned entities, and property acquired in a like-kind exchange can involve special rules. In an exchange, the replacement property's basis may be partly carried over from the relinquished property, and bonus treatment can depend on rules for the exchanged and excess basis. This is technical. See Section 1031 Exchanges and Depreciation Recapture.

What about prior use by you

If you owned the property earlier, for example if you sell and buy back, or convert from personal use, the treatment can differ. A property converted from personal use to rental may have special rules about basis and placed-in-service date. Ask your preparer.

Impact on catch-up studies

If you are catching up on an older property using a method change, the rules that applied in the year the property was placed in service govern the options. See Catch-Up Depreciation With Form 3115 and Bonus Depreciation History and Why to Stay Cautious.

Documentation

Document the acquisition: the purchase agreement, the identity of the seller, the relationship if any, and the closing statement. If the property is ever reviewed, these facts support eligibility.

Land improvements and used property

Land improvements are generally 15 year property and can qualify as used property in the same way. Confirm that the site items were part of the acquisition. See Land Improvements and the 15 Year Class.

Furnishings bought separately

Items you buy new, such as furniture for a rental, are treated as new property, and separate rules apply to them. Keep receipts. See Examples of 5 and 7 Year Property in Rentals and Commercial Buildings.

A checklist to bring to your preparer

1. Who was the seller and any relationship?
2. Was the purchase a sale, exchange, or gift?
3. Did you or a related party previously use the property?
4. What is the placed-in-service date?
5. What bonus percentage applies?

Records that support eligibility

Keep the purchase agreement, the closing statement, the seller's identity, any documents showing relationships between the parties, and your own history with the property. If the transaction was structured as anything other than a straightforward purchase, tell your preparer. Documentation of the acquisition is the foundation for a claim of eligibility, so it deserves the same care as the study itself.

When eligibility is uncertain

Where eligibility is uncertain, you can model the case without bonus, consider whether to elect out, or ask your preparer for a written analysis of the facts. Do not rely on a provider's blanket statement that all used property qualifies. Each transaction stands on its own facts.

Illustrative situations in words

An investor buys an apartment building from an unrelated seller in an arm's-length sale. The building's components were used by the seller. Under the general conditions described, the investor's purchase is the type of transaction that can meet the used-property conditions, though the preparer must confirm.

Another investor buys a building from a business partner's affiliated entity. The relationship may raise questions under the related-party rules. The preparer should review before the study relies on bonus.

A third investor previously owned the property, sold it, and later bought it back. Whether the earlier ownership disqualifies components depends on the details. Extra care is warranted.

Why the review matters

Bonus on reclassified assets can be a large part of the deduction, so eligibility is a big variable. It is better to confirm eligibility before the study is ordered so that the estimate is realistic. If eligibility is doubtful, the analysis should include a case without bonus.

Next steps

Continue with Bonus Depreciation: Rules as Currently Understood (Verify) and Year of Acquisition: Why Timing Matters for a Study.