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Related Party Considerations Under TCJA
The Tax Cuts and Jobs Act (“TCJA”) introduced new provisions to the Internal Revenue Code (“the Code”), which unsurprisingly rely on longstanding concepts within tax law. One of these concepts are with respect to related party transactions and the disallowance of expenses and losses with respect to such transactions. In this post we will touch on two provisions of the TCJA:
- Section 168(k) (Special Allowance for Certain Property – Bonus Depreciation) and
- Section 199A (Qualified Business Income Deduction).
Related Party Expensing and Loss Disallowance
Both 168(k) and 199A have reference to related party provisions via the code section 179(d)(2). Section 179 of the Code allows for expensing of certain property purchased by the taxpayer in the year that such assets are placed into service. Section 179(d)(2) sets out the definition of a “purchase”, excluding the purchase of property acquired from a person whose relationship to the acquirer would result in disallowance of losses under section 267 or 707(b). Below is a excerpt from the code:
Section 267(a) disallows loss deductions resulting from sales or exchanges of property, directly or indirectly, between related parties and provides for a matching rule for interest and expenses deductions, between such parties. Section 267(b) defines a list of related party relationships, including
- Siblings, spouses, ancestors, and lineal descendants and
- Certain relationships involving trusts, partnerships, corporations, and charitable organizations.
This definition of relationships not only applies to Sec 267, but also for several other provisions within the Code, including section 707(b) which provides similar disallowance and matching rules for transactions between certain partners and a partnership or two partnerships if common ownership requirements are met.
TCJA – “Bonus Depreciation”
TCJA made a few key changes to section 168(k), highlighted below:
| Pre-TCJA | TCJA | |
| Allowance | 50% | 100% |
| Qualified Property | New property only. | Can be “used” or “new ” property as long as requirements of 179(d)(2)(A) are met. [1] |
[1] Section 179(d)(2)(A) excludes the application of siblings from the related party definition. Section 168(k) is not permitted if the taxpayer acquires the used property from a “related party”. Further if used property is purchased, the taxpayer must not have previously used the property.
TCJA – “Qualified Business Income Deduction”
In addition to changes in Bonus Depreciation, the TCJA also introduced section 199A, which generally provides a 20% deduction for qualified business income a taxpayer receives through a sole proprietorship, partnership, or S corporation.
- Type of Income: The qualified business income generally excludes portfolio income and compensation income, with some exceptions.
- Qualified Business: Income must come from a qualified trade or business, which excludes the performance of services as an employee. Particular service businesses are excluded from the definition of qualified trade or business. The 199A deduction for each qualified trade or business is limited to the greater of:
(i) 50% of the w-2 wages paid by the qualified trade or business OR
(ii) 25% of the w-2 wages paid by the qualified trade or business PLUS 2.5% of the unadjusted basis immediately after acquisition of all qualified property of the qualified trade or business (Wages Plus Property Test).
With respect to the Wage Plus Property test, there are a few other key items to consider. First, only property whose depreciable period has not ended coins as qualified property. For purposes of the Wages Plus Property Test, the applicable depreciation period is the greater of:
(i) Ten years OR
(ii) The applicable recovery period under section 168.
In addition to the above, Congress ordered the Treasury to apply rules to prevent the use of related-party transactions to manipulate the depreciable period of otherwise fully depreciable property, and applied the rules in section 179(d)(2).
Conclusion
Section 168(k) bonus depreciation and 199A qualified business income deduction both provide significant benefits to qualifying taxpayers. However, if you typically purchase property from related parties, or are considering such transactions, you must consider the potential disallowance of these benefits.
Disclaimer: The information provided herein is intended solely for informational purposes and no person(s) or other third-party may rely upon it as financial, tax, or legal advice or use it for any other purposes. As a result, Royal Financial, and any affiliates, assume no responsibility whatsoever to readers, or any other persons for that matter, as a result of the information contained herein.