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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

TD 9091

RIN 1545-BC19

Special Depreciation Allowance

AGENCY: Internal Revenue Service (IRS), Treasury

ACTION: Final and temporary regulations.

SUMMARY: This document contains regulations relating to the depreciation
of property subject to section 168 of the Internal Revenue Code (MACRS
property) and the depreciation of computer software subject to section
167. Specifically, these regulations provide guidance regarding the
additional first year depreciation allowance provided by sections 168(k)
and 1400L(b) for certain MACRS property and computer software. The
regulations reflect changes to the law made by the Job Creation and
Worker Assistance Act of 2002 and the Jobs and Growth Tax Relief
Reconciliation Act of 2003. The text of these temporary regulations also
serves as the text of the proposed regulations set forth in the notice
of proposed rulemaking on this subject in the Proposed Rules section in
this issue of the **Federal Register**.

DATES: [Effective Dates]{.underline}: These regulations are effective
September 8, 2003.

[Applicability Dates]{.underline}: For dates of applicability, see
§§1.167(a)-14T(e), 1.168(d)-1T(d), 1.168(k)-1T(g), 1.169-3T(g), and
1.1400L(b)-1T(g).

FOR FURTHER INFORMATION CONTACT: Douglas Kim, (202) 622-3110 (not a
toll-free number).

SUPPLEMENTARY INFORMATION:

**Background**

This document contains amendments to 26 CFR part 1 to provide
regulations under sections 168(k) and 1400L(b) of the Internal Revenue
Code (Code). Sections 168(k) and 1400L(b) were added to the Code by,
respectively, sections 101 and 301(a) of the Job Creation and Worker
Assistance Act of 2002, Public Law 107-147 (116 Stat. 21), and were
modified by section 201 of the Jobs and Growth Tax Relief Reconciliation
Act of 2003, Public Law 108-27 (117 Stat. 752).

**Explanation of Provisions**

[Background]{.underline}

Section 167 allows as a depreciation deduction a reasonable allowance
for the exhaustion, wear, and tear of property used in a trade or
business or held for the production of income. The depreciation
allowable for tangible, depreciable property placed in service after
1986 generally is determined under section 168 (MACRS property). The
depreciation allowable for computer software that is placed in service
after August 10, 1993, and is not an amortizable section 197 intangible
is determined under section 167(f)(1).

Section 168(k)(1) allows a 30-percent additional first year depreciation
deduction for qualified property acquired after September 10, 2001, and,
in most cases, placed in service before January 1, 2005. Section
168(k)(4) allows a 50-percent additional first year depreciation
deduction for 50-percent bonus depreciation property acquired after May
5, 2003, and, in most cases, placed in service before January 1, 2005.
Section 1400L(b) allows a 30-percent additional first year depreciation
deduction for qualified New York Liberty Zone property (Liberty Zone
property) acquired after September 10, 2001, and placed in service
before January 1, 2007 (January 1, 2010, in the case of qualifying
nonresidential real property and residential rental property).

[Scope]{.underline}

The regulations provide the requirements that must be met for
depreciable property to qualify for the additional first year
depreciation deduction provided by sections 168(k) and 1400L(b).
Further, the regulations instruct taxpayers how to determine the
additional first year depreciation deduction and the amount of
depreciation otherwise allowable for this property.

[Property Eligible for the Additional First Year Depreciation
Deduction]{.underline}

The regulations provide that depreciable property must meet four
requirements to be qualified property under section 168(k)(2) (property
for which the 30-percent additional first year depreciation deduction is
allowable) or 50-percent bonus depreciation property under section
168(k)(4) (property for which the 50-percent additional first year
depreciation deduction is allowable). These requirements are: (1) the
depreciable property must be of a specified type; (2) the original use
of the depreciable property must commence with the taxpayer after
September 10, 2001, for qualified property or after May 5, 2003, for
50-percent bonus depreciation property; (3) the depreciable property
must be acquired by the taxpayer within a specified time period; and (4)
the depreciable property must be placed in service by a specified date.
These requirements are more fully discussed below.

[Property of a Specified Type]{.underline}

The regulations provide that qualified property or 50-percent bonus
depreciation property must be one of the following: (1) MACRS property
that has a recovery period of 20 years of less; (2) computer software as
defined in, and depreciated under, section 167(f)(1); (3) water utility
property as defined in section 168(e)(5) and depreciated under section
168; or (4) qualified leasehold improvement property depreciated under
section 168. Because the additional first year depreciation deduction
applies to MACRS property that is depreciated under the general
depreciation system (GDS) or would be depreciated under the GDS but for
an alternative depreciation system (ADS) election made by the taxpayer,
the regulations provide that for purposes of determining the eligibility
of MACRS property as qualified property or 50-percent bonus depreciation
property, the recovery period applicable for the MACRS property under
section 168(c) of the GDS is used regardless of any election made by the
taxpayer to depreciate the class of property under the ADS of section
168(g). Further, with respect to qualified leasehold improvement
property, the regulations define those improvements specified in section
168(k)(3)(B) that are not considered as qualified leasehold improvement
property.

The regulations also provide that qualified property or 50-percent bonus
depreciation property does not include: (1) property excluded from the
application of section 168 as a result of section 168(f); (2) property
that is required to be depreciated under the ADS; (3) any class of
property for which the taxpayer elects not to deduct the 30-percent or
50-percent additional first year depreciation; or (4) qualified New York
Liberty Zone leasehold improvement property as defined in section
1400L(c).

Property is required to be depreciated under the ADS if the property is
described under section 168(g)(1)(A) through (D) or if other provisions
of the Code require depreciation for the property to be determined under
the ADS (for example, section 263A(e)(2)(A) or section 280F(b)(1)).
Thus, MACRS property for which the taxpayer makes an election under
section 168(g)(7) to depreciate the property under the ADS is eligible
for the additional first year depreciation deduction (assuming all other
requirements are met).

With respect to the election out of the additional first year
depreciation deduction, a taxpayer may elect out of the 30-percent
additional first year depreciation deduction for any class of qualified
property. For any class of 50-percent bonus depreciation property, a
taxpayer may elect either to deduct the 30-percent, instead of the
50-percent, additional first year depreciation deduction or to deduct no
additional first year depreciation deduction. The regulations provide
the rules for making these elections and also define what is a class of
property for purposes of the elections.

[Original Use]{.underline}

Pursuant to section 168(k)(2)(A)(ii), the regulations provide that
qualified property is property the original use of which commences with
the taxpayer after September 10, 2001. Further, pursuant to section
168(k)(4)(B)(i), the regulations provide that 50-percent bonus
depreciation property is property the original use of which commences
with the taxpayer after May 5, 2003. The regulations provide that the
original use generally means the first use to which the property is put,
whether or not that use corresponds to the use of the property by the
taxpayer. Thus, new property initially used by a taxpayer for personal
use and then subsequently converted by the taxpayer for use in its trade
or business satisfies the original use requirement. However, new
property acquired by a taxpayer for personal use and then subsequently
acquired by a different taxpayer for use in its trade or business does
not satisfy the original use requirement.

Likewise, additional capital expenditures incurred by a taxpayer to
recondition or rebuild property acquired or owned by the taxpayer
satisfies the original use requirement. However, the cost of
reconditioned or rebuilt property acquired by the taxpayer does not
satisfy the original use requirement. The question of whether property
is reconditioned or rebuilt property is a question of fact. The
regulations provide a safe harbor that property containing used parts
will not be treated as reconditioned or rebuilt if the cost of the used
parts is not more than 20 percent of the total cost of the property. See
Rev. Rul. 68-111 (1968-1 C.B. 29).

The regulations also provide special rules for certain sale-leaseback
transactions and syndication transactions. If qualified property is
originally placed in service after September 10, 2001, or 50-percent
bonus depreciation property is originally placed in service after May 5,
2003, by a person and the property is involved in a sale-leaseback
transaction described in section 168(k)(2)(D)(ii), the taxpayer-lessor
is considered the original user of the property. Likewise, if qualified
property is originally placed in service by a lessor after September 10,
2001, or 50-percent bonus depreciation property is originally placed in
service by a lessor after May 5, 2003, and is sold by the lessor or any
subsequent purchaser within three months after the date the property was
originally placed in service by the lessor, and the user of the property
does not change during this three-month period, the purchaser of the
property in the last sale is considered the original user of the
property.

The regulations also provide that if in the ordinary course of its
business a taxpayer sells fractional interests in qualified property or
50-percent bonus depreciation property to unrelated third parties, each
first fractional owner of the property is considered as the original
user of its proportionate share of the property. Furthermore, if a
taxpayer uses the qualified property or the 50-percent bonus
depreciation property before all of the fractional interests are sold
and the property continues to be held primarily for sale by the
taxpayer, the original use of any fractional interest sold to an
unrelated third party subsequent to the taxpayer's use begins with the
first purchaser of that interest.

[Acquisition of Property]{.underline}

Pursuant to section 168(k)(2)(A)(iii), the regulations provide that
qualified property is property: (1) acquired by the taxpayer after
September 10, 2001, and before January 1, 2005, but only if no written
binding contract for the acquisition of the property was in effect
before September 11, 2001; or (2) acquired by the taxpayer pursuant to a
written binding contract that was entered into after September 10, 2001,
and before January 1, 2005. Further, pursuant to section
168(k)(4)(B)(ii), the regulations provide that 50-percent bonus
depreciation property is property acquired by the taxpayer after May 5,
2003, and before January 1, 2005, but only if no written binding
contract for the acquisition of the property was in effect before May 6,
2003.

The regulations define a binding contract as any contract that is
enforceable under State law against the taxpayer or a predecessor, and
does not limit damages to a specified amount. However, a contractual
provision that limits damages to an amount equal to at least 5 percent
of the total contract price will not be treated as limiting damages to a
specified amount. Further, the fact that there will be little or no
damages because the contract price does not significantly differ from
the fair market value will not be taken into account in determining
whether a contract limits damages.

The regulations also provide that a contract is binding even if the
contract is subject to a condition, as long as the condition is not
within the control of either one of the parties or a predecessor.
Further, an option to either acquire or sell property is not treated as
a binding contract.

The regulations also provide that a binding contract does not include a
supply agreement or similar agreement, if the amount and design
specifications of the property to be purchased have not been specified.
In this case, the contract is not treated as a binding contract until
both the amount and design specifications are specified.

With respect to self-constructed property, the regulations provide that
the property acquisition requirement is met if a taxpayer manufactures,
constructs, or produces qualified property or 50-percent bonus
depreciation property for its own use and such manufacturing,
construction, or production began after, respectively, September 10,
2001, or May 5, 2003, and before January 1, 2005. Further, property that
is manufactured, constructed, or produced for the taxpayer by another
person under a written binding contract that is entered into before the
manufacture, construction, or production of the property begins is
considered to be manufactured, constructed, or produced by the taxpayer.

The regulations also define when construction begins. Construction of
qualified property or 50-percent bonus depreciation property begins when
physical work of a significant nature begins. Physical work does not
include preliminary activities such as planning or designing, securing
financing, exploring, or researching. The determination of when physical
work of a significant nature has begun depends on the facts and
circumstances. The regulations, however, provide a safe harbor that
physical work of a significant nature has begun when the taxpayer incurs
or pays more than 10 percent of the total cost of the property
(excluding the cost of any land and preliminary activities).

The regulations also provide rules for a contract to acquire, or for the
manufacture, construction, or production of, a component of the larger
self-constructed property. If a binding contract to acquire a component
was in effect, or the manufacture, construction, or production of a
component began, before September 11, 2001, for qualified property or
before May 6, 2003, for 50-percent bonus depreciation property, the
component does not qualify for the additional first year depreciation
deduction. Similarly, if a binding contract to acquire a component was
in effect, or the manufacture, construction, or production of a
component began, before September 11, 2001, for qualified property or
before May 6, 2003, for 50-percent bonus depreciation property, but the
manufacture, construction, or production of the larger self-constructed
property began after September 10, 2001, for qualified property, or
after May 5, 2003, for 50-percent bonus depreciation property, and
before January 1, 2005, the larger self-constructed property qualifies
for the additional first year depreciation deduction (assuming all other
requirements are met) but the component does not. Additionally, if the
manufacture, construction, or production of the larger self-constructed
property began before September 11, 2001, for qualified property or
before May 6, 2003, for 50-percent bonus depreciation property, the
larger self-constructed property and any acquired or self-constructed
component related to the larger self-constructed property do not qualify
for the 30-percent or 50-percent additional first year depreciation
deduction. However, if the binding contract to acquire the component was
entered into, or the manufacture, construction, or production of the
component began, after September 10, 2001, for qualified property, or
after May 5, 2003, for 50-percent bonus depreciation property, and
before January 1, 2005, but the manufacture, construction, or production
of the larger self-constructed property begins after December 31, 2004,
the component qualifies for the additional first year depreciation
deduction (assuming all other requirements are met) but the larger
self-constructed property does not.

The regulations provide rules for when certain acquired or
self-constructed property will not meet the acquisition date requirement
(disqualified transactions). When the user of property as of the date on
which the property was originally placed in service, or a related party
to the user, acquired, or had a written binding contract in effect for
the acquisition of, the property at any time before September 11, 2001,
or before May 6, 2003, as applicable, the property does not qualify for
the 30-percent or 50-percent additional first year depreciation
deduction. Similarly, property manufactured, constructed, or produced
for the taxpayer or a related party does not qualify for the 30-percent
or 50-percent additional first year depreciation deduction if the
manufacture, construction, or production began at any time before
September 11, 2001, or before May 6, 2003, as applicable. For this
purpose, persons are related if they have a relationship specified in
section 267(b) or 707(b).

[Placed-in-service Date]{.underline}

Pursuant to section 168(k)(2)(A)(iv) and 168(k)(4)(B)(iii), the
regulations provide that qualified property or 50-percent bonus
depreciation property is property that is placed in service by the
taxpayer before January 1, 2005. However, the placed in service date of
January 1, 2005, is extended for one year to January 1, 2006, for
property described in section 168(k)(2)(B).

The regulations also provide special rules for sale-leaseback
transactions and syndication transactions. If qualified property is
originally placed in service after September 10, 2001, or 50-percent
bonus depreciation property is originally placed in service after May 5,
2003, by a person and is involved in a sale-leaseback transaction
described in section 168(k)(2)(D)(ii), the property is treated as
originally placed in service by the taxpayer-lessor not earlier than the
date on which the property is used by the lessee under the
sale-leaseback. Likewise, if qualified property is originally placed in
service by a lessor after September 10, 2001, or 50-percent bonus
depreciation property is originally placed in service by a lessor after
May 5, 2003, and is sold by the lessor or any subsequent purchaser
within three months after the date the property was originally placed in
service by the lessor, and the user of the property does not change
during this three-month period, the property is treated as originally
placed in service not earlier than the date of the last sale by the
purchaser of the property in the last sale. Special rules also are
provided for certain nonrecognition transactions. In the case of a
technical termination of a partnership under section 708(b)(1)(B),
qualified property or 50-percent bonus depreciation property placed in
service by the terminated partnership during the taxable year of
termination is treated as originally placed in service by the new
partnership on the date the qualified property or the 50-percent bonus
depreciation property is contributed by the terminated partnership to
the new partnership. Additionally, qualified property or 50-percent
bonus depreciation property transferred in a "step-in-the-shoes"
transaction described in section 168(i)(7) in the taxable year the
qualified property or the 50-percent bonus depreciation property is
placed in service by the transferor is treated as originally placed in
service on the date the transferor placed the qualified property or the
50-percent bonus depreciation property in service.

[Liberty Zone Property]{.underline}

Generally, the requirements for determining the eligibility of property
for the additional first year depreciation deduction for Liberty Zone
property provided by section 1400L(b) are similar to the requirements
for the 30-percent additional first year depreciation deduction for
qualified property provided by section 168(k)(1). There are, however,
some differences that are discussed below.

The regulations provide that Liberty Zone property includes the same
property that is described as qualified property or 50-percent bonus
depreciation property for purposes of section 168(k). In addition,
Liberty Zone property includes nonresidential real property or
residential rental property to the extent such property rehabilitates
real property damaged, or replaces real property destroyed or condemned,
as a result of the terrorist attacks of September 11, 2001. Property is
treated as replacing destroyed or condemned property if, as part of an
integrated plan, the property replaces real property that is included in
a continuous area that includes real property destroyed or condemned.
Real property is considered to have been destroyed or condemned only if
an entire building or structure was destroyed or condemned as a result
of the terrorist attacks of September 11, 2001.

While Liberty Zone property includes the same property that is described
as qualified property or 50-percent bonus depreciation property for
purposes of section 168(k), only one additional first year depreciation
deduction is allowable for the property. Thus, pursuant to section
1400L(b)(2)(C)(i), the regulations provide that if the 30-percent or
50-percent additional first year depreciation deduction under section
168(k) applies to the property, it is not Liberty Zone property.

Pursuant to section 1400L(b)(2)(A)(ii), property is Liberty Zone
property if substantially all of the use of the property is in the
Liberty Zone and the property is used in the active conduct of a
taxpayer's trade or business in the Liberty Zone. The regulations
provide that the term [substantially all]{.underline} means 80 percent
or more.

In addition to the application of the original use rules for qualified
property, the regulations provide that used property will satisfy the
original use requirement for Liberty Zone property if the used property
has not been previously used within the Liberty Zone.

Pursuant to section 1400L(b)(2)(A)(iv), the regulations provide that
Liberty Zone property is property that is acquired by the taxpayer by
purchase after September 10, 2001, but only if no written binding
contract for the acquisition of the property was in effect before
September 10, 2001. The term [by purchase]{.underline} is defined in
section 179(d) and §1.179-4(c). The regulations also provide that the
binding contract rules and the disqualified transactions rules for
qualified property apply to Liberty Zone property. The self-construction
rules for qualified property also apply to self-constructed Liberty Zone
property except that the requirement to begin the manufacture,
construction, or production of the qualified property before January 1,
2005, does not apply to Liberty Zone property.

Finally, the regulations provide that Liberty Zone property generally
must be acquired by a taxpayer after September 10, 2001, and placed in
service by the taxpayer before January 1, 2007. However, qualifying
nonresidential real property and residential rental property must be
acquired by a taxpayer after September 10, 2001, and placed in service
by the taxpayer before January 1, 2010.

[Computation of Additional First Year Depreciation Deduction and
Otherwise Allowable Depreciation]{.underline}

The allowable additional first year depreciation deduction for qualified
property or Liberty Zone property is equal to 30 percent of the
unadjusted depreciable basis (as defined in §1.168(k)-1T(a)(2)(iii)) of
the property. The allowable additional first year depreciation deduction
for 50-percent bonus depreciation property is equal to 50 percent of the
unadjusted depreciable basis (as defined in §1.168(k)-1T(a)(2)(iii)) of
the property. For qualified property or 50-percent bonus depreciation
property described in section 168(k)(2)(B) (property having a longer
production period), the unadjusted depreciable basis (as defined in
§1.168(k)-1T(a)(2)(iii)) of the property is limited to the property's
basis attributable to manufacture, construction, or production of the
property before January 1, 2005.

The additional first year depreciation deduction is allowed for both
regular tax and alternative minimum tax purposes. However, for
alternative minimum tax purposes, the amount of the additional first
year depreciation deduction is based on the unadjusted depreciable basis
of the property for alternative minimum tax purposes. The amount of the
additional first year depreciation deduction is not affected by a
taxable year of less than 12 months for either regular or alternative
minimum tax purposes.

Before determining the amount of depreciation otherwise allowable for
qualified property, 50-percent bonus depreciation property, or Liberty
Zone property, the taxpayer must first reduce the unadjusted depreciable
basis (as defined in §1.168(k)-1T(a)(2)(iii)) of the property by the
amount of the additional first year depreciation deduction allowed or
allowable, whichever is greater (the remaining adjusted depreciable
basis). Then, the remaining adjusted depreciable basis is depreciated
using the applicable depreciation provisions of the Code for the
property (that is, section 168 for MACRS property and section 167(f)(1)
for computer software). This amount of depreciation is allowed for both
regular tax and alternative minimum tax purposes, and is affected by a
taxable year of less than 12 months. However, for alternative minimum
tax purposes, the amount of depreciation allowed is determined by
calculating the remaining adjusted depreciable basis of the property for
alternative minimum tax purposes and using the same depreciation method,
recovery period, and convention that applies to the property for regular
tax purposes. If a taxpayer uses the optional depreciation tables in
Rev. Proc. 87-57 (1987-2 C.B. 687) to compute depreciation for qualified
property, 50-percent bonus depreciation property, or Liberty Zone
property that is MACRS property, the regulations also provide that the
remaining adjusted depreciable basis of the property is the basis to
which the annual depreciation rates in those tables apply.

[Special Rules]{.underline}

The regulations also provide rules for the following situations: (1)
qualified property, 50-percent bonus depreciation property, or Liberty
Zone property placed in service and disposed of in the same taxable
year; (2) redetermination of basis of qualified property, 50-percent
bonus depreciation property, or Liberty Zone property; (3) recapture of
additional first year depreciation for purposes of section 1245 and
section 1250; (4) a certified pollution control facility that is
qualified property, 50-percent bonus depreciation property, or Liberty
Zone property; (5) like-kind exchanges and involuntary conversions of
qualified property, 50-percent bonus depreciation property, or Liberty
Zone property; (6) a change in use of qualified property, 50-percent
bonus depreciation property, or Liberty Zone property; (7) the
computation of earnings and profits; (8) the increase in the limitation
of the amount of depreciation for passenger automobiles; and (9) the
step-up in basis due to a section 754 election.

With respect to qualified property, 50-percent bonus depreciation
property, or Liberty Zone property placed in service and disposed of in
the same taxable year, the regulations provide that the additional first
year depreciation deduction is not allowed. This rule is consistent with
the general rule in §1.168(d)-1(b)(3)(ii) for MACRS property placed in
service and disposed of in the same taxable year. However, as previously
discussed, the additional first year depreciation deduction is allowable
for qualified property, 50-percent bonus depreciation property, or
Liberty Zone property placed in service by a terminated partnership in
the same taxable year in which a technical termination of the
partnership occurs. In this case, the new partnership, and not the
terminated partnership, claims the additional first year depreciation
deduction. Similarly, the additional first year depreciation deduction
is allowable for qualified property, 50-percent bonus depreciation
property, or Liberty Zone property placed in service by a transferor in
the same taxable year in which the property is transferred in a
step-in-the-shoes transaction described in section 168(i)(7). In this
case, the additional first year depreciation deduction for the
transferor's taxable year in which the property is placed in service is
allocated between the transferor and the transferee on a monthly basis.
The allocation shall be made in accordance with the rules in
§1.168(d)-1(b)(7)(ii) for allocating the depreciation deduction between
the transferor and the transferee.

The regulations also provide rules for a redetermination of basis of
qualified property, 50-percent bonus depreciation property, or Liberty
Zone property (for example, due to a contingent purchase price or a
discharge of indebtedness). If the unadjusted depreciable basis of the
property is redetermined by the date on which the property must be last
placed in service to meet the placed-in-service date requirement in
section 168(k)(2)(A)(iv), 168(k)(4)(B)(iii), or 1400L(b)(2)(A)(v), the
additional first year depreciation deduction allowable for the property
is redetermined. If the redetermination of basis occurs after that date,
the additional first year depreciation deduction is not redetermined.
The regulations instruct taxpayers how to determine the depreciation
adjustment for an increase or decrease in basis. If there is an increase
in basis, the taxpayer claims the additional first year depreciation
deduction attributable to the increase in the taxable year in which the
increase occurs. If there is a decrease in basis, the taxpayer includes
in its income the excess additional first year depreciation deduction
attributable to the decrease in the taxable year in which the decrease
occurs.

Because the additional first year depreciation deduction is not a
ratable method of computing depreciation, the regulations provide that
the additional first year depreciation deduction is not a straight line
method for purposes of section 1250. Thus, the additional first year
depreciation deduction is an accelerated depreciation method for
purposes of determining recapture under section 1250. For purposes of
section 1245, all depreciation deductions are subject to recapture.

With respect to a certified pollution control facility that is qualified
property, 50-percent bonus depreciation property, or Liberty Zone
property, the regulations provide that the additional first year
depreciation deduction is allowable in the facility's placed in service
year even if the taxpayer elects to amortize the basis of the facility
under section 169 in the placed-in-service year. The regulations also
amend the regulations under section 169 to provide that the amortizable
basis under section 169 must be reduced by the additional first year
depreciation deduction allowed or allowable, whichever is greater,
applicable to the facility.

With respect to MACRS property or computer software acquired in a
like-kind exchange under section 1031 or as a result of an involuntary
conversion under section 1033, the regulations provide that the
carryover basis and the excess basis, if any, of the acquired MACRS
property or acquired computer software are eligible for the additional
first year depreciation deduction if the acquired MACRS property or
acquired computer software is qualified property, 50-percent bonus
depreciation property, or Liberty Zone property. However, if qualified
property, 50-percent bonus depreciation property, or Liberty Zone
property is placed in service and then disposed of in an exchange or
involuntary conversion in the same taxable year, the unadjusted
depreciable basis of the exchanged or involuntarily converted property
is not eligible for the additional first year depreciation deduction.

The regulations also provide rules when the use of qualified property,
50-percent bonus depreciation property, or Liberty Zone property changes
in the hands of the same taxpayer during the placed-in-service year or a
subsequent taxable year. The regulations provide that no additional
first year depreciation deduction is allowed for qualified property,
50-percent bonus depreciation property, or Liberty Zone property
converted to personal use in the placed-in-service year. However,
property converted to business or income-producing use is eligible for
the additional first year depreciation deduction in the taxable year the
property is converted to business or income-producing use (assuming all
the requirements are met). With respect to a change in the use of
depreciable property subsequent to the placed-in-service year, the
regulations provide that the change in the use will not affect the
determination of whether the property was eligible for the additional
first year depreciation deduction in the taxable year the property was
originally placed-in-service. Thus, if property is not qualified
property in its placed-in-service year and a change in the use in a
subsequent taxable year would result in the property being qualified
property, no additional first year depreciation deduction is allowed for
the property. Likewise, if property is qualified property in its
placed-in-service year and a change in the use in a subsequent taxable
year would result in the property no longer being qualified property,
the additional first year depreciation deduction allowable for the
property in its placed-in-service year is not redetermined.

Furthermore, the regulations provide that the additional first year
depreciation deduction is not allowable for purposes of computing
earnings and profits. Pursuant to section 168(k)(2)(E) and (4)(D), the
regulations also provide the increase in the limitation under section
280F(a)(1) of the amount of depreciation for certain passenger
automobiles that are qualified property or 50-percent bonus depreciation
property. Finally, the regulations provide that any increase in basis of
qualified property, 50-percent bonus depreciation property, or Liberty
Zone property due to a section 754 election generally is not eligible
for the additional first year depreciation deduction because any such
increase in basis of property does not satisfy the original use
requirement.

**Special Analyses**

It has been determined that this Treasury decision is not a significant
regulatory action as defined in Executive Order 12866. Therefore, a
regulatory assessment is not required. It also has been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)
does not apply to these regulations and, because these regulations do
not impose on small entities a collection of information requirement,
the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply.
Therefore, a Regulatory Flexibility Analysis is not required. Pursuant
to section 7805(f) of the Code, these temporary regulations will be
submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on its impact on small business.

**Drafting Information**

The principal author of these regulations is Douglas H. Kim, Office of
Associate Chief Counsel (Passthroughs and Special Industries). However,
other personnel from the IRS and Treasury Department participated in
their development.

**List of Subjects in 26 CFR Part 1**

Income taxes, Reporting and recordkeeping requirements.

**Adoption of Amendments to the Regulations**

Accordingly, 26 CFR part 1 is amended as follows:

PART 1\--INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in part
as follows:

Authority: 26 U.S.C. 7805 \* \* \*

Par. 2. Section 1.167(a)-14 is amended by:

1\. Revising paragraphs (b)(1) and (e)(2).

2\. Revising paragraph heading (e).

3\. Adding paragraph (e)(3).

The additions and revisions read as follows:

[§1.167(a)-14 Treatment of certain intangible property excluded from
section 197]{.underline}.

\* \* \* \* \*

\(b\) \* \* \*

\(1\) [In general]{.underline}. \[Reserved\]. For further guidance, see
§1.167(a)-14T(b)(1).

\* \* \* \* \*

\(e\) [Effective dates]{.underline} \* \* \*

\(2\) [Change in method of accounting]{.underline}. \[Reserved\]. For
further guidance, see §1.167(a)-14T(e)(2).

\(3\) [Qualified property, 50-percent bonus depreciation property,
qualified New York Liberty Zone property, or section 179
property]{.underline}. \[Reserved\]. For further guidance, see
§1.167(a)-14T(e)(3).

Par. 3. Section 1.167(a)-14T is added to read as follows:

[§1.167(a)-14T Treatment of certain intangible property excluded from
section 197 (temporary)]{.underline}.

\(a\) For further guidance, see §1.167(a)-14(a).

\(b\) [Computer software]{.underline}\--(1) [In general]{.underline}.
The amount of the deduction for computer software described in section
167(f)(1) and §1.197-2(c)(4) is determined by amortizing the cost or
other basis of the computer software using the straight line method
described in §1.167(b)-1 (except that its salvage value is treated as
zero) and an amortization period of 36 months beginning on the first day
of the month that the computer software is placed in service. Before
determining the amortization deduction allowable under this paragraph
(b), the cost or other basis of computer software that is section 179
property, as defined in section 179(d)(1)(A)(ii), must be reduced for
any portion of the basis the taxpayer properly elects to treat as an
expense under section 179. In addition, the cost or other basis of
computer software that is qualified property under section 168(k)(2) or
§1.168(k)-1T, 50-percent bonus depreciation property under section
168(k)(4) or §1.168(k)-1T, or qualified New York Liberty Zone property
under section 1400L(b) or §1.1400L(b)-1T, must be reduced by the amount
of the additional first year depreciation deduction allowed or
allowable, whichever is greater, under section 168(k) or section
1400L(b) for the computer software. If costs for developing computer
software that the taxpayer properly elects to defer under section 174(b)
result in the development of property subject to the allowance for
depreciation under section 167, the rules of this paragraph (b) will
apply to the unrecovered costs. In addition, this paragraph (b) applies
to the cost of separately acquired computer software if the cost to
acquire the software is separately stated and the cost is required to be
capitalized under section 263(a).

(b)(2) through (e)(1) For further guidance, see §1.167(a)-14(b)(2)
through (e)(1).

(e)(2) [Change in method of accounting]{.underline}. See §1.197-2(l)(4)
for rules relating to changes in method of accounting for property to
which §1.167(a)-14T applies. However, see §1.168(k)-1T(g)(4) or
1.1400L(b)-1T(g)(4) for rules relating to changes in method of
accounting for computer software to which the third sentence in
§1.167(a)-14T(b)(1) applies.

\(3\) [Qualified property, 50-percent bonus depreciation property,
qualified New York Liberty Zone property, or section 179
property]{.underline}. This section also applies to computer software
that is qualified property under section 168(k)(2) or qualified New York
Liberty Zone property under section 1400L(b) acquired by a taxpayer
after September 10, 2001, and to computer software that is 50-percent
bonus depreciation property under section 168(k)(4) acquired by a
taxpayer after May 5, 2003. This section also applies to computer
software that is section 179 property placed in service by a taxpayer in
a taxable year beginning after 2002 and before 2006. This section
expires on September 7, 2006.

Par. 4. Section 1.168(d)-1 is amended by:

1\. Revising paragraph (b)(3)(ii).

2\. Paragraph heading (d) is revised and the text of paragraph (d) is
redesignated as paragraph (d)(1).

3\. Adding paragraph (d)(2).

The additions and revisions read as follows:

[§1.168(d)-1 Applicable conventions\--half-year and mid-quarter
conventions]{.underline}.

\* \* \* \* \*

\(b\) \* \* \*

\(3\) \* \* \*

\(ii\) \[Reserved\]. For further guidance, see §1.168(d)-1T(b)(3)(ii).

\* \* \* \* \*

\(d\) [Effective dates]{.underline}\--(1) [In general]{.underline}. \*
\* \*

\(2\) [Qualified property, 50-percent bonus depreciation property, or
qualified New York Liberty Zone property]{.underline}. \[Reserved\]. For
further guidance, see §1.168(d)-1T(d).

Par. 5. Section 1.168(d)-1T is added to read as follows:

[§1.168(d)-1T Applicable conventions\--half-year and mid-quarter
conventions (temporary)]{.underline}.

\(a\) through (b)(3)(i) For further guidance, see §1.168(d)-1(a) through
(b)(3)(i).

(b)(3)(ii) The applicable convention, as determined under this section,
applies to all depreciable property (except nonresidential real
property, residential rental property, and any railroad grading or
tunnel bore) placed in service during the taxable year, excluding
property placed in service and disposed of in the same taxable year. No
depreciation deduction is allowed for property placed in service and
disposed of during the same taxable year. However, see
§1.168(k)-1T(f)(1) for qualified property or 50-percent bonus
depreciation property, and §1.1400L(b)-1T(f)(1) for qualified New York
Liberty Zone property, that is placed in service in the same taxable
year in which either a partnership is terminated as a result of a
technical termination under section 708(b)(1)(B) or the property is
transferred in a transaction described in section 168(i)(7).

(b)(3)(iii) through (d)(1) For further guidance, see
§1.168(d)-1(b)(3)(iii) through (d)(1).

(d)(2) [Qualified property, 50-percent bonus depreciation property, or
qualified New York Liberty Zone property]{.underline}. This section also
applies to qualified property under section 168(k)(2) or qualified New
York Liberty Zone property under section 1400L(b) acquired by a taxpayer
after September 10, 2001, and to 50-percent bonus depreciation property
under section 168(k)(4) acquired by a taxpayer after May 5, 2003. This
section expires on September 7, 2006.

Par. 6. Section 1.168(k)-0T is added to read as follows:

[§1.168(k)-0T Table of contents (temporary)]{.underline}.

This section lists the headings that appear in §1.168(k)-1T.

§1.168(k)-1T Additional first year depreciation deduction (temporary).

\(a\) Scope and definitions.

\(1\) Scope.

\(2\) Definitions.

\(b\) Qualified property or 50-percent bonus depreciation property.

\(1\) In general.

\(2\) Description of qualified property or 50-percent bonus depreciation
property.

\(i\) In general.

\(ii\) Property not eligible for additional first year depreciation
deduction.

\(A\) Property that is not qualified property.

\(B\) Property that is not 50-percent bonus depreciation property.

\(3\) Original use.

\(i\) In general.

\(ii\) Conversion to business or income-producing use.

\(iii\) Sale-leaseback and syndication transactions.

\(A\) Sale-leaseback transaction.

\(B\) Syndication transaction.

\(C\) Sale-leaseback transaction followed by a syndication transaction.

\(iv\) Fractional interests in property.

\(v\) Examples.

\(4\) Acquisition of property.

\(i\) In general.

\(A\) Qualified property.

\(B\) 50-percent bonus depreciation property.

\(ii\) Definition of binding contract.

\(A\) In general.

\(B\) Conditions.

\(C\) Options.

\(D\) Supply agreements.

\(E\) Components.

\(iii\) Self-constructed property.

\(A\) In general.

\(B\) When does construction begin.

\(C\) Components of self-constructed property.

[(1)]{.underline} Acquired components.

[(2)]{.underline} Self-constructed components.

\(iv\) Disqualified transactions.

\(A\) In general.

\(B\) Related party defined.

\(v\) Examples.

\(5\) Placed-in-service date.

\(i\) In general.

\(ii\) Sale-leaseback and syndication transactions.

\(A\) Sale-leaseback transaction.

\(B\) Syndication transaction.

\(C\) Sale-leaseback transaction followed by a syndication transaction.

\(iii\) Technical termination of a partnership.

\(iv\) Section 168(i)(7) transactions.

\(c\) Qualified leasehold improvement property.

\(1\) In general.

\(2\) Certain improvements not included.

\(3\) Definitions.

\(d\) Computation of depreciation deduction for qualified property or
50-percent bonus depreciation property.

\(1\) Additional first year depreciation deduction.

\(i\) In general.

\(ii\) Property having a longer production period.

\(iii\) Alternative minimum tax.

\(2\) Otherwise allowable depreciation deduction.

\(i\) In general.

\(ii\) Alternative minimum tax.

\(3\) Examples.

\(e\) Election not to deduct additional first year depreciation.

\(1\) In general.

\(i\) Qualified property.

\(ii\) 50-percent bonus depreciation property.

\(2\) Definition of class of property.

\(3\) Time and manner for making election.

\(i\) Time for making election.

\(ii\) Manner of making election.

\(4\) Special rules for 2000 or 2001 returns.

\(5\) Failure to make election.

\(f\) Special rules.

\(1\) Property placed in service and disposed of in the same taxable
year.

\(i\) In general.

\(ii\) Technical termination of a partnership.

\(iii\) Section 168(i)(7) transactions.

\(iv\) Examples.

\(2\) Redetermination of basis.

\(i\) Increase in basis.

\(ii\) Decrease in basis.

\(iii\) Definition.

\(iv\) Examples.

\(3\) Section 1245 and 1250 depreciation recapture.

\(4\) Coordination with section 169.

\(5\) Like-kind exchanges and involuntary conversions.

\(i\) Scope.

\(ii\) Definitions.

\(iii\) Computation.

\(A\) In general.

\(B\) Year of disposition and year of replacement.

\(iv\) Sale-leasebacks.

\(v\) Examples.

\(6\) Change in use.

\(i\) Change in use of depreciable property.

\(ii\) Conversion to personal use.

\(iii\) Conversion to business or income-producing use.

\(A\) During the same taxable year.

\(B\) Subsequent to the acquisition year.

\(iv\) Depreciable property changes use subsequent to the
placed-in-service year.

\(v\) Examples.

\(7\) Earnings and profits.

\(8\) Limitation of amount of depreciation for certain passenger
automobiles.

\(9\) Section 754 election.

\(g\) Effective date.

\(1\) In general.

\(2\) Technical termination of a partnership or section 168(i)(7)
transactions.

\(3\) Like-kind exchanges and involuntary conversions.

\(4\) Change in method of accounting.

\(i\) Special rules for 2000 or 2001 returns.

\(ii\) Like-kind exchanges and involuntary conversions.

Par. 7. Section 1.168(k)-1T is added to read as follows:

[§1.168(k)-1T Additional first year depreciation deduction
(temporary)]{.underline}.

\(a\) [Scope and definitions]{.underline}\--(1) [Scope]{.underline}.
This section provides the rules for determining the 30-percent
additional first year depreciation deduction allowable under section
168(k)(1) for qualified property and the 50-percent additional first
year depreciation deduction allowable under section 168(k)(4) for
50-percent bonus depreciation property.

\(2\) [Definitions]{.underline}. For purposes of section 168(k) and this
section, the following definitions apply:

\(i\) [Depreciable property]{.underline} is property that is of a
character subject to the allowance for depreciation as determined under
section 167 and the regulations thereunder.

\(ii\) [MACRS property]{.underline} is tangible, depreciable property
that is placed in service after December 31, 1986 (or after July 31,
1986, if the taxpayer made an election under section 203(a)(1)(B) of the
Tax Reform Act of 1986; 100 Stat. 2143) and subject to section 168,
except for property excluded from the application of section 168 as a
result of section 168(f) or as a result of a transitional rule.

\(iii\) [Unadjusted depreciable basis]{.underline} is the basis of
property for purposes of section 1011 without regard to any adjustments
described in section 1016(a)(2) and (3). This basis reflects the
reduction in basis for the percentage of the taxpayer\'s use of property
for the taxable year other than in the taxpayer\'s trade or business (or
for the production of income), for any portion of the basis the taxpayer
properly elects to treat as an expense under section 179, and for any
adjustments to basis provided by other provisions of the Internal
Revenue Code and the regulations thereunder (other than section
1016(a)(2) and (3)) (for example, a reduction in basis by the amount of
the disabled access credit pursuant to section 44(d)(7)). For property
subject to a lease, see section 167(c)(2).

\(iv\) [Adjusted depreciable basis]{.underline} is the unadjusted
depreciable basis of the property, as defined in
§1.168(k)-1T(a)(2)(iii), less the adjustments described in section
1016(a)(2) and (3).

\(b\) [Qualified property or 50-percent bonus depreciation
property]{.underline}\--(1) [In general]{.underline}. Qualified property
or 50-percent bonus depreciation property is depreciable property
that\--

\(i\) Meets the requirements in §1.168(k)-1T(b)(2) (description of
property);

\(ii\) Meets the requirements in §1.168(k)-1T(b)(3) (original use);

\(iii\) Meets the requirements in §1.168(k)-1T(b)(4) (acquisition of
property); and

\(iv\) Meets the requirements in §1.168(k)-1T(b)(5) (placed-in-service
date).

\(2\) [Description of qualified property or 50-percent bonus
depreciation property]{.underline}\--(i) [In general]{.underline}.
Depreciable property will meet the requirements of this paragraph (b)(2)
if the property is\--

\(A\) MACRS property (as defined in §1.168(k)-1T(a)(2)(ii)) that has a
recovery period of 20 years or less. For purposes of this paragraph
(b)(2)(i)(A) and section 168(k)(2)(B)(i)(II) and 168(k)(4)(C), the
recovery period is determined in accordance with section 168(c)
regardless of any election made by the taxpayer under section 168(g)(7);

\(B\) Computer software as defined in, and depreciated under, section
167(f)(1) and the regulations thereunder;

\(C\) Water utility property as defined in section 168(e)(5) and
depreciated under section 168; or

\(D\) Qualified leasehold improvement property as defined in paragraph
(c) of this section and depreciated under section 168.

\(ii\) [Property not eligible for additional first year depreciation
deduction]{.underline}\--(A) [Property that is not qualified
property]{.underline}. For purposes of the 30-percent additional first
year depreciation deduction, depreciable property will not meet the
requirements of this paragraph (b)(2) if the property is\--

([1]{.underline}) Described in section 168(f);

([2]{.underline}) Required to be depreciated under the alternative
depreciation system of section 168(g) pursuant to section 168(g)(1)(A)
through (D) or other provisions of the Internal Revenue Code (for
example, property described in section 263A(e)(2)(A) or section
280F(b)(1));

([3]{.underline}) Included in any class of property for which the
taxpayer elects not to deduct the 30-percent additional first year
depreciation (for further guidance, see paragraph (e) of this section);
or

([4]{.underline}) Qualified New York Liberty Zone leasehold improvement
property as defined in section 1400L(c)(2).

\(B\) [Property that is not 50-percent bonus depreciation
property]{.underline}. For purposes of the 50-percent additional first
year depreciation deduction, depreciable property will not meet the
requirements of this paragraph (b)(2) if the property is\--

([1]{.underline}) Described in paragraph (b)(2)(ii)(A)([1]{.underline}),
([2]{.underline}), or ([4]{.underline}) of this section; or

([2]{.underline}) Included in any class of property for which the
taxpayer elects the 30-percent, instead of the 50-percent, additional
first year depreciation deduction or elects not to deduct any additional
first year depreciation (for further guidance, see paragraph (e) of this
section).

\(3\) [Original use]{.underline}\--(i) [In general]{.underline}. For
purposes of the 30-percent additional first year depreciation deduction,
depreciable property will meet the requirements of this paragraph (b)(3)
if the original use of the property commences with the taxpayer after
September 10, 2001. For purposes of the 50-percent additional first year
depreciation deduction, depreciable property will meet the requirements
of this paragraph (b)(3) if the original use of the property commences
with the taxpayer after May 5, 2003. Except as provided in paragraph
(b)(3)(iii) and (iv) of this section, original use means the first use
to which the property is put, whether or not that use corresponds to the
use of the property by the taxpayer. Thus, additional capital
expenditures incurred by a taxpayer to recondition or rebuild property
acquired or owned by the taxpayer satisfies the original use
requirement. However, the cost of reconditioned or rebuilt property
acquired by the taxpayer does not satisfy the original use requirement.
The question of whether property is reconditioned or rebuilt property is
a question of fact. For purposes of this paragraph (b)(3)(i), property
that contains used parts will not be treated as reconditioned or rebuilt
if the cost of the used parts is not more than 20 percent of the total
cost of the property.

\(ii\) [Conversion to business or income-producing use]{.underline}. If
a taxpayer initially acquires new property for personal use and
subsequently uses the property in the taxpayer\'s trade or business or
for the taxpayer\'s production of income, the taxpayer is considered as
the original user of the property. If a person initially acquires new
property for personal use and a taxpayer subsequently acquires the
property from the person for use in the taxpayer\'s trade or business or
for the taxpayer\'s production of income, the taxpayer is not considered
the original user of the property.

\(iii\) [Sale-leaseback and syndication transactions]{.underline}\--(A)
[Sale-leaseback transaction]{.underline}. If new property is originally
placed in service by a person after September 10, 2001 (for qualified
property), or after May 5, 2003 (for 50-percent bonus depreciation
property), and is sold to a taxpayer and leased back to the person by
the taxpayer within three months after the date the property was
originally placed in service by the person, the taxpayer-lessor is
considered the original user of the property.

\(B\) [Syndication transaction]{.underline}. If new property is
originally placed in service by a lessor (including by operation of
paragraph (b)(5)(ii)(A) of this section) after September 10, 2001 (for
qualified property), or after May 5, 2003 (for 50-percent bonus
depreciation property), and is sold by the lessor or any subsequent
purchaser within three months after the date the property was originally
placed in service by the lessor, and the user of the property after the
last sale during the three-month period remains the same as when the
property was originally placed in service by the lessor, the purchaser
of the property in the last sale during the three-month period is
considered the original user of the property.

\(C\) [Sale-leaseback transaction followed by a syndication
transaction]{.underline}. If a sale-leaseback transaction that satisfies
the requirements in paragraph (b)(3)(iii)(A) of this section is followed
by a syndication transaction that satisfies the requirements in
paragraph (b)(3)(iii)(B) of this section, the original user of the
property is determined in accordance with paragraph (b)(3)(iii)(B) of
this section.

\(iv\) [Fractional interests in property]{.underline}. If, in the
ordinary course of its business, a taxpayer sells fractional interests
in property to unrelated third parties, each first fractional owner of
the property is considered as the original user of its proportionate
share of the property. Furthermore, if the taxpayer uses the property
before all of the fractional interests of the property are sold but the
property continues to be held primarily for sale by the taxpayer, the
original use of any fractional interest sold to an unrelated third party
subsequent to the taxpayer's use of the property begins with the first
purchaser of that fractional interest. For purposes of this paragraph
(b)(3)(iv), persons are not related if they do not have a relationship
described in section 267(b) or 707(b) and the regulations thereunder.

\(v\) [Examples]{.underline}. The application of this paragraph (b)(3)
is illustrated by the following examples:

[Example 1]{.underline}. On August 1, 2002, [A]{.underline} buys from
[B]{.underline} for \$20,000 a machine that has been previously used by
[B]{.underline} in [B]{.underline}'s trade or business. On March 1,
2003, [A]{.underline} makes a \$5,000 capital expenditure to recondition
the machine. The \$20,000 purchase price does not qualify for the
additional first year depreciation deduction because the original use
requirement of this paragraph (b)(3) is not met. However, the \$5,000
expenditure satisfies the original use requirement of this paragraph
(b)(3) and, assuming all other requirements are met, qualifies for the
30-percent additional first year depreciation deduction, regardless of
whether the \$5,000 is added to the basis of the machine or is
capitalized as a separate asset.

[Example 2]{.underline}. [C]{.underline}, an automobile dealer, uses
some of its automobiles as demonstrators in order to show them to
prospective customers. The automobiles that are used as demonstrators by
[C]{.underline} are held by [C]{.underline} primarily for sale to
customers in the ordinary course of its business. On September 1, 2002,
[D]{.underline} buys from [C]{.underline} an automobile that was
previously used as a demonstrator by [C]{.underline}. [D]{.underline}
will use the automobile solely for business purposes. The use of the
automobile by [C]{.underline} as a demonstrator does not constitute a
"use" for purposes of the original use requirement and, therefore,
[D]{.underline} will be considered the original user of the automobile
for purposes of this paragraph (b)(3). Assuming all other requirements
are met, [D]{.underline}'s purchase price of the automobile qualifies
for the 30-percent additional first year depreciation deduction for
[D]{.underline}, subject to any limitation under section 280F.

[Example 3]{.underline}. On April 1, 2000, [E]{.underline} acquires a
horse to be used in [E]{.underline}'s thoroughbred racing business. On
October 1, 2003, [F]{.underline} buys the horse from [E]{.underline} and
will use the horse in [F]{.underline}'s horse breeding business. The use
of the horse by [E]{.underline} in its racing business prevents the
original use of the horse from commencing with [F]{.underline}. Thus,
[F]{.underline}'s purchase price of the horse does not qualify for the
additional first year depreciation deduction.

[Example 4]{.underline}. In the ordinary course of its business,
[G]{.underline} sells fractional interests in its aircraft to unrelated
parties. [G]{.underline} holds out for sale eight equal fractional
interests in an aircraft. On January 1, 2003, [G]{.underline} sells five
of the eight fractional interests in the aircraft to [H]{.underline}, an
unrelated party, and [H]{.underline} begins to use its proportionate
share of the aircraft immediately upon purchase. On June 1, 2003,
[G]{.underline} sells to [I]{.underline}, an unrelated party to
[G]{.underline} and [H]{.underline}, the remaining unsold 3/8 fractional
interests in the aircraft. [H]{.underline} is considered the original
user as to its 5/8 fractional interest in the aircraft and
[I]{.underline} is considered the original user as to its 3/8 fractional
interest in the aircraft. Thus, assuming all other requirements are met,
[H]{.underline}'s purchase price for its 5/8 fractional interest in the
aircraft qualifies for the 30-percent additional first year depreciation
deduction and [I]{.underline}'s purchase price for its 3/8 fractional
interest in the aircraft qualifies for the 50-percent additional first
year depreciation deduction.

\(4\) [Acquisition of property]{.underline}\--(i) [In
general]{.underline}\--(A) [Qualified property]{.underline}. For
purposes of the 30-percent additional first year depreciation deduction,
depreciable property will meet the requirements of this paragraph (b)(4)
if the property is\--

([1]{.underline}) Acquired by the taxpayer after September 10, 2001, and
before January 1, 2005, but only if no written binding contract for the
acquisition of the property was in effect before September 11, 2001; or

([2]{.underline}) Acquired by the taxpayer pursuant to a written binding
contract that was entered into after September 10, 2001, and before
January 1, 2005.

\(B\) [50-percent bonus depreciation property]{.underline}. For purposes
of the 50-percent additional first year depreciation deduction,
depreciable property will meet the requirements of this paragraph (b)(4)
if the property is acquired by the taxpayer after May 5, 2003, and
before January 1, 2005, but only if no written binding contract for the
acquisition of the property was in effect before May 6, 2003.

\(ii\) [Definition of binding contract]{.underline}\--(A) [In
general]{.underline}. A contract is binding only if it is enforceable
under State law against the taxpayer or a predecessor, and does not
limit damages to a specified amount (for example, by use of a liquidated
damages provision). For this purpose, a contractual provision that
limits damages to an amount equal to at least 5 percent of the total
contract price will not be treated as limiting damages to a specified
amount. In determining whether a contract limits damages, the fact that
there may be little or no damages because the contract price does not
significantly differ from fair market value will not be taken into
account. For example, if a taxpayer entered into an irrevocable written
contract to purchase an asset for \$100 and the contract contained no
provision for liquidated damages, the contract is considered binding
notwithstanding the fact that the asset had a fair market value of \$99
and under local law the seller would only recover the difference in the
event the purchaser failed to perform. If the contract provided for a
full refund of the purchase price in lieu of any damages allowable by
law in the event of breach or cancellation by the seller, the contract
is not considered binding.

\(B\) [Conditions]{.underline}. A contract is binding even if subject to
a condition, as long as the condition is not within the control of
either party or a predecessor. A contract will continue to be binding if
the parties make insubstantial changes in its terms and conditions or
because any term is to be determined by a standard beyond the control of
either party. A contract that imposes significant obligations on the
taxpayer or a predecessor will be treated as binding notwithstanding the
fact that insubstantial terms remain to be negotiated by the parties to
the contract.

\(C\) [Options]{.underline}. An option to either acquire or sell
property is not a binding contract.

\(D\) [Supply agreements]{.underline}. A binding contract does not
include a supply or similar agreement if the amount and design
specifications of the property to be purchased have not been specified.
The contract will not be a binding contract for the property to be
purchased until both the amount and the design specifications are
specified. For example, if the provisions of a supply or similar
agreement state the design specifications of, and the pricing for, the
property to be purchased, a purchase order under the agreement for a
specific number of assets is treated as a binding contract.

\(E\) [Components]{.underline}. A binding contract to acquire one or
more components of a larger property will not be treated as a binding
contract to acquire the larger property. If a binding contract to
acquire the component does not satisfy the requirements of this
paragraph (b)(4), the component does not qualify for the 30-percent or
50-percent additional first year depreciation deduction, as applicable.

\(iii\) [Self-constructed property]{.underline}\--(A) [In
general]{.underline}. If a taxpayer manufactures, constructs, or
produces property for use by the taxpayer in its trade or business (or
for its production of income), the acquisition rules in paragraph
(b)(4)(i) of this section are treated as met for qualified property if
the taxpayer begins manufacturing, constructing, or producing the
property after September 10, 2001, and before January 1, 2005, and for
50-percent bonus depreciation property if the taxpayer begins
manufacturing, constructing, or producing the property after May 5,
2003, and before January 1, 2005. Property that is manufactured,
constructed, or produced for the taxpayer by another person under a
written binding contract (as defined in paragraph (b)(4)(ii) of this
section) that is entered into prior to the manufacture, construction, or
production of the property for use by the taxpayer in its trade or
business (or for its production of income) is considered to be
manufactured, constructed, or produced by the taxpayer.

\(B\) [When does construction begin]{.underline}. For purposes of
paragraph (b)(4)(iii) of this section, construction of property begins
when physical work of a significant nature begins. Physical work does
not include preliminary activities such as planning or designing,
securing financing, exploring, or researching. The determination of when
physical work of a significant nature begins depends on the facts and
circumstances. For purposes of this paragraph (b)(4)(iii)(B), physical
work of a significant nature will not be considered to begin before the
taxpayer incurs (in the case of an accrual basis taxpayer) or pays (in
the case of a cash basis taxpayer) more than 10 percent of the total
cost of the property (excluding the cost of any land and preliminary
activities such as planning or designing, securing financing, exploring,
or researching). For example, if a retail motor fuels outlet is to be
constructed on-site, construction begins when physical work of a
significant nature commences at the site; that is, when work begins on
the excavation for footings, pouring the pads for the outlet, or the
driving of foundation pilings into the ground. Preliminary work, such as
clearing a site, test drilling to determine soil condition, or
excavation to change the contour of the land (as distinguished from
excavation for footings) does not constitute the beginning of
construction. However, if a retail motor fuels outlet is to be assembled
on-site from modular units constructed off-site and delivered to the
site where the outlet will be used, construction begins when physical
work of a significant nature commences at the off-site location.

\(C\) [Components of self-constructed
property]{.underline}\--([1]{.underline}) [Acquired
components]{.underline}. If a binding contract (as defined in paragraph
(b)(4)(ii) of this section) to acquire a component does not satisfy the
requirements of paragraph (b)(4)(i) of this section, the component does
not qualify for the 30-percent or 50-percent additional first year
depreciation deduction, as applicable. A binding contract (as defined in
paragraph (b)(4)(ii) of this section) to acquire one or more components
of a larger self-constructed property will not preclude the larger
self-constructed property from satisfying the acquisition rules in
paragraph (b)(4)(iii)(A) of this section. Accordingly, the unadjusted
depreciable basis of the larger self-constructed property that is
eligible for the 30-percent or 50-percent additional first year
depreciation deduction, as applicable (assuming all other requirements
are met), must not include the unadjusted depreciable basis of any
component that does not satisfy the requirements of paragraph (b)(4)(i)
of this section. If the manufacture, construction, or production of the
larger self-constructed property begins before September 11, 2001, for
qualified property, or before May 6, 2003, for 50-percent bonus
depreciation property, the larger self-constructed property and any
acquired components related to the larger self-constructed property do
not qualify for the 30-percent or 50-percent additional first year
depreciation deduction, as applicable. If a binding contract to acquire
the component is entered into after September 10, 2001, for qualified
property, or after May 5, 2003, for 50-percent bonus depreciation
property, and before January 1, 2005, but the manufacture, construction,
or production of the larger self-constructed property does not begin
before January 1, 2005, the component qualifies for the additional first
year depreciation deduction (assuming all other requirements are met)
but the larger self-constructed property does not.

\(2\) [Self-constructed components]{.underline}. If the manufacture,
construction, or production of a component does not satisfy the
requirements of paragraph (b)(4)(iii)(A) of this section, the component
does not qualify for the 30-percent or 50-percent additional first year
depreciation deduction, as applicable. However, if the manufacture,
construction, or production of a component does not satisfy the
requirements of paragraph (b)(4)(iii)(A) of this section, but the
manufacture, construction, or production of the larger self-constructed
property satisfies the requirements of paragraph (b)(4)(iii)(A) of this
section, the larger self-constructed property qualifies for the
30-percent or 50-percent additional first year depreciation deduction,
as applicable (assuming all other requirements are met) even though the
component does not qualify for the 30-percent or 50-percent additional
first year depreciation deduction. Accordingly, the unadjusted
depreciable basis of the larger self-constructed property that is
eligible for the 30-percent or 50-percent additional first year
depreciation deduction, as applicable (assuming all other requirements
are met), must not include the unadjusted depreciable basis of any
component that does not qualify for the 30-percent or 50-percent
additional first year depreciation deduction. If the manufacture,
construction, or production of the larger self-constructed property
began before September 11, 2001, for qualified property, or before May
6, 2003, for 50-percent bonus depreciation property, the larger
self-constructed property and any self-constructed components related to
the larger self-constructed property do not qualify for the 30-percent
or 50-percent additional first year depreciation deduction, as
applicable. If the manufacture, construction, or production of a
component begins after September 10, 2001, for qualified property, or
after May 5, 2003, for 50-percent bonus depreciation property, and
before January 1, 2005, but the manufacture, construction, or production
of the larger self-constructed property does not begin before January 1,
2005, the component qualifies for the additional first year depreciation
deduction (assuming all other requirements are met) but the larger
self-constructed property does not.

\(iv\) [Disqualified transactions]{.underline}\--(A) [In
general]{.underline}. Property does not satisfy the requirements of this
paragraph (b)(4) if the user of the property as of the date on which the
property was originally placed in service (including by operation of
paragraph (b)(5)(ii), (iii), and (iv) of this section), or a related
party to the user, acquired, or had a written binding contract (as
defined in paragraph (b)(4)(ii) of this section) in effect for the
acquisition of, the property at any time before September 11, 2001 (for
qualified property), or before May 6, 2003 (for 50-percent bonus
depreciation property). In addition, property manufactured, constructed,
or produced for the taxpayer or a related party does not satisfy the
requirements of this paragraph (b)(4) if the manufacture, construction,
or production of the property for the taxpayer or a related party began
at any time before September 11, 2001 (for qualified property), or
before May 6, 2003 (for 50-percent bonus depreciation property).

\(B\) [Related party defined]{.underline}. For purposes of this
paragraph (b)(4)(iv), persons are related if they have a relationship
specified in section 267(b) or 707(b) and the regulations thereunder.

\(v\) [Examples]{.underline}. The application of this paragraph (b)(4)
is illustrated by the following examples:

[Example 1]{.underline}. On September 1, 2001, [J]{.underline}, a
corporation, entered into a written agreement with [K]{.underline}, a
manufacturer, to purchase 20 new lamps for \$100 each within the next
two years. Although the agreement specifies the number of lamps to be
purchased, the agreement does not specify the design of the lamps to be
purchased. Accordingly, the agreement is not a binding contract pursuant
to paragraph (b)(4)(ii)(D) of this section.

[Example 2]{.underline}. Same facts as [Example 1]{.underline}. On
December 1, 2001, [J]{.underline} placed a purchase order with
[K]{.underline} to purchase 20 new model XPC5 lamps for \$100 each for a
total amount of \$2,000. Because the agreement specifies the number of
lamps to be purchased and the purchase order specifies the design of the
lamps to be purchased, the purchase order placed by [J]{.underline} with
[K]{.underline} on December 1, 2001, is a binding contract pursuant to
paragraph (b)(4)(ii)(D) of this section. Accordingly, the cost of the 20
lamps qualifies for the 30-percent additional first year depreciation
deduction.

[Example 3]{.underline}. Same facts as [Example 1]{.underline} except
that the written agreement between [J]{.underline} and [K]{.underline}
is to purchase 100 model XPC5 lamps for \$100 each within the next two
years. Because this agreement specifies the amount and design of the
lamps to be purchased, the agreement is a binding contract pursuant to
paragraph (b)(4)(ii)(D) of this section. Accordingly, because the
agreement was entered into before September 11, 2001, any lamp acquired
by [J]{.underline} under this contract does not qualify for the
additional first year depreciation deduction.

[Example 4]{.underline}. On September 1, 2001, [L]{.underline} began
constructing an electric generation power plant for its own use. On
November 1, 2002, [L]{.underline} ceases construction of the power plant
prior to its completion. Between September 1, 2001, and November 1,
2002, [L]{.underline} incurred \$3,000,000 for the construction of the
power plant. On May 6, 2003, [L]{.underline} resumed construction of the
power plant and completed its construction on August 31, 2003. Between
May 6, 2003, and August 31, 2003, [L]{.underline} incurred another
\$1,600,000 to complete the construction of the power plant and, on
September 1, 2003, [L]{.underline} placed the power plant in service.
None of [L]{.underline}'s total expenditures of \$4,600,000 qualify for
the additional first year depreciation deduction because, pursuant to
paragraph (b)(4)(iii)(A) of this section, [L]{.underline} began
constructing the power plant before September 11, 2001.

[Example 5]{.underline}. Same facts as [Example 4]{.underline} except
that [L]{.underline} began constructing the electric generation power
plant for its own use on October 1, 2001. [L]{.underline}'s total
expenditures of \$4,600,000 qualify for the additional first year
depreciation deduction because, pursuant to paragraph (b)(4)(iii)(A) of
this section, [L]{.underline} began constructing the power plant after
September 10, 2001, and placed the power plant in service before January
1, 2005. Accordingly, the additional first year depreciation deduction
for the power plant will be \$1,380,000, computed as \$4,600,000
multiplied by 30 percent.

[Example 6]{.underline}. On August 1, 2001, [M]{.underline} entered into
a written binding contract to acquire a new turbine. The new turbine is
a component part of a new electric generation power plant that is being
constructed on [M]{.underline}'s behalf. The construction of the new
electric generation power plant commenced in November 2001, and the new
electric generation power plant was completed in November 2002. Because
[M]{.underline} entered into a written binding contract to acquire a
component part (the new turbine) prior to September 11, 2001, pursuant
to paragraph (b)(4)(iii)(C) of this section, the component part does not
qualify for the additional first year depreciation deduction. However,
pursuant to paragraphs (b)(4)(iii)(A) and (C) of this section, the new
plant constructed for [M]{.underline} will qualify for the 30-percent
additional first year depreciation deduction because construction of the
new plant began after September 10, 2001, and before May 6, 2003.
Accordingly, the unadjusted depreciable basis of the new plant that is
eligible for the 30-percent additional first year depreciation deduction
must not include the unadjusted depreciable basis of the new turbine.

[Example 7]{.underline}. Same facts as [Example 6]{.underline} except
that [M]{.underline} entered into the written binding contract to
acquire the new turbine on September 30, 2002, and construction of the
new plant commenced on August 1, 2001. Because [M]{.underline} began
construction of the new plant prior to September 11, 2001, pursuant to
paragraphs (b)(4)(iii)(A) and (C) of this section, neither the new plant
constructed for [M]{.underline} nor the turbine will qualify for the
additional first year depreciation deduction because self-construction
of the new plant began prior to September 11, 2001.

[Example 8]{.underline}. On September 1, 2001, [N]{.underline} began
constructing property for its own use. On October 1, 2001,
[N]{.underline} sold its rights to the property to [O]{.underline}, a
related party under section 267(b). Pursuant to paragraph (b)(4)(iv) of
this section, the property is not eligible for the additional first year
depreciation deduction because [N]{.underline} and [O]{.underline} are
related parties and construction of the property by [N]{.underline}
began prior to September 11, 2001.

[Example 9]{.underline}. On September 1, 2001, [P]{.underline} entered
into a written binding contract to acquire property. On October 1, 2001,
[P]{.underline} sold its rights to the property to [Q]{.underline}, a
related party under section 267(b). Pursuant to paragraph (b)(4)(iv) of
this section, the property is not eligible for the additional first year
depreciation deduction because [P]{.underline} and [Q]{.underline} are
related parties and a written binding contract for the acquisition of
the property was in effect prior to September 11, 2001.

[Example 10]{.underline}. Prior to September 11, 2001, [R]{.underline}
began constructing an electric generation power plant for its own use.
On May 1, 2003, prior to the completion of the power plant,
[R]{.underline} transferred the rights to own and use this power plant
to [S]{.underline}, an unrelated party, for \$6,000,000. Between May 6,
2003, and June 30, 2003, [S]{.underline}, a calendar-year taxpayer,
incurred another \$1,200,000 to complete the construction of the power
plant and, on August 1, 2003, [S]{.underline} placed the power plant in
service. Because [R]{.underline} and [S]{.underline} are not related
parties, the transaction between [R]{.underline} and [S]{.underline}
will not be a disqualified transaction pursuant to paragraph (b)(4)(iv)
of this section. Accordingly, [S]{.underline}'s total expenditures of
\$7,200,000 for the power plant qualify for the additional first year
depreciation deduction. [S]{.underline}'s additional first year
depreciation deduction for the power plant will be \$2,400,000, computed
as \$6,000,000 multiplied by 30 percent, plus \$1,200,000 multiplied by
50 percent. The \$6,000,000 portion of the total \$7,200,000 unadjusted
depreciable basis qualifies for the 30-percent additional first year
depreciation deduction because that portion of the total unadjusted
depreciable basis was acquired by [S]{.underline} after September 10,
2001, and before May 6, 2003. However, because [S]{.underline} began
construction to complete the power plant after May 5, 2003, the
\$1,200,000 portion of the total \$7,200,000 unadjusted depreciable
basis qualifies for the 50-percent additional first year depreciation
deduction.

[Example 11]{.underline}. On September 1, 2001, [T]{.underline} acquired
and placed in service equipment. On October 15, 2001, [T]{.underline}
sells the equipment to [U]{.underline}, an unrelated party, and leases
the property back from [U]{.underline} in a sale-leaseback transaction.
Pursuant to paragraph (b)(4)(iv) of this section, the equipment does not
qualify for the additional first year depreciation deduction because
[T]{.underline}, the user of the equipment, acquired the equipment prior
to September 11, 2001.

\(5\) [Placed-in-service date]{.underline}\--(i) [In
general]{.underline}. Depreciable property will meet the requirements of
this paragraph (b)(5) if the property is placed in service by the
taxpayer before January 1, 2005, or, in the case of property described
in section 168(k)(2)(B), is placed in service by the taxpayer before
January 1, 2006.

\(ii\) [Sale-leaseback and syndication transactions]{.underline}\--(A)
[Sale-leaseback transaction]{.underline}. If qualified property is
originally placed in service after September 10, 2001, or 50-percent
bonus depreciation property is originally placed in service after May 5,
2003, by a person and sold to a taxpayer and leased back to the person
by the taxpayer within three months after the date the property was
originally placed in service by the person, the property is treated as
originally placed in service by the taxpayer-lessor not earlier than the
date on which the property is used by the lessee under the leaseback.

\(B\) [Syndication transaction]{.underline}. If qualified property is
originally placed in service after September 10, 2001, or 50-percent
bonus depreciation property is originally placed in service after May 5,
2003, by a lessor (including by operation of paragraph (b)(5)(ii)(A) of
this section) and is sold by the lessor or any subsequent purchaser
within three months after the date the property was originally placed in
service by the lessor, and the user of the property after the last sale
during this three-month period remains the same as when the property was
originally placed in service by the lessor, the property is treated as
originally placed in service by the purchaser of the property in the
last sale during the three-month period but not earlier than the date of
the last sale.

\(C\) [Sale-leaseback transaction followed by a syndication
transaction]{.underline}. If a sale-leaseback transaction that satisfies
the requirements in paragraph (b)(5)(ii)(A) of this section is followed
by a syndication transaction that satisfies the requirements in
paragraph (b)(5)(ii)(B) of this section, the placed-in-service date of
the property is determined in accordance with paragraph (b)(5)(ii)(B) of
this section.

\(iii\) [Technical termination of a partnership]{.underline}. For
purposes of this paragraph (b)(5), in the case of a technical
termination of a partnership under section 708(b)(1)(B), qualified
property or 50-percent bonus depreciation property placed in service by
the terminated partnership during the taxable year of termination is
treated as originally placed in service by the new partnership on the
date the qualified property or the 50-percent bonus depreciation
property is contributed by the terminated partnership to the new
partnership.

\(iv\) [Section 168(i)(7) transactions]{.underline}. For purposes of
this paragraph (b)(5), if qualified property or 50-percent bonus
depreciation property is transferred in a transaction described in
section 168(i)(7) in the same taxable year that the qualified property
or the 50-percent bonus depreciation property is placed in service by
the transferor, the transferred property is treated as originally placed
in service on the date the transferor placed in service the qualified
property or the 50-percent bonus depreciation property, as applicable.
In the case of multiple transfers of qualified property or 50-percent
bonus depreciation property in multiple transactions described in
section 168(i)(7) in the same taxable year, the placed in service date
of the transferred property is deemed to be the date on which the first
transferor placed in service the qualified property or the 50-percent
bonus depreciation property, as applicable.

\(c\) [Qualified leasehold improvement property]{.underline}\--(1) [In
general]{.underline}. For purposes of section 168(k), qualified
leasehold improvement property means any improvement, which is section
1250 property, to an interior portion of a building that is
nonresidential real property if\--

\(i\) The improvement is made under or pursuant to a lease by the lessee
(or any sublessee) of the interior portion, or by the lessor of that
interior portion;

\(ii\) The interior portion of the building is to be occupied
exclusively by the lessee (or any sublessee) of that interior portion;
and

\(iii\) The improvement is placed in service more than 3 years after the
date the building was first placed in service by any person.

\(2\) [Certain improvements not included]{.underline}. Qualified
leasehold improvement property does not include any improvement for
which the expenditure is attributable to:

\(i\) The enlargement of the building;

\(ii\) Any elevator or escalator;

\(iii\) Any structural component benefiting a common area; or

\(iv\) The internal structural framework of the building.

\(3\) [Definitions]{.underline}. For purposes of this paragraph (c), the
following definitions apply:

\(i\) [Building]{.underline} has the same meaning as that term is
defined in §1.48-1(e)(1).

\(ii\) [Common area]{.underline} means any portion of a building that is
equally available to all users of the building on the same basis for
uses that are incidental to the primary use of the building. For
example, stairways, hallways, lobbies, common seating areas, interior
and exterior pedestrian walkways and pedestrian bridges, loading docks
and areas, and rest rooms generally are treated as common areas if they
are used by different lessees of a building.

\(iii\) [Elevator]{.underline} and [escalator]{.underline} have the same
meanings as those terms are defined in §1.48-1(m)(2).

\(iv\) [Enlargement]{.underline} has the same meaning as that term is
defined in §1.48-12(c)(10).

\(v\) [Internal structural framework]{.underline} has the same meaning
as that term is defined in §1.48-12(b)(3)(i)(D)(iii).

\(vi\) [Lease]{.underline} has the same meaning as that term is defined
in section 168(h)(7). In addition, a commitment to enter into a lease is
treated as a lease, and the parties to the commitment are treated as
lessor and lessee. However, a lease between related persons is not
considered a lease. For purposes of the preceding sentence, related
persons are\--

\(A\) Members of an affiliated group (as defined in section 1504 and the
regulations thereunder); and

\(B\) Persons having a relationship described in section 267(b) and the
regulations thereunder. For purposes of applying section 267(b), the
language "80 percent or more" is used instead of "more than 50 percent."

\(vii\) [Nonresidential real property]{.underline} has the same meaning
as that term is defined in section 168(e)(2)(B).

\(viii\) [Structural component]{.underline} has the same meaning as that
term is defined in §1.48-1(e)(2).

\(d\) [Computation of depreciation deduction for qualified property or
50-percent bonus depreciation property]{.underline}\--(1) [Additional
first year depreciation deduction]{.underline}\--(i) [In
general]{.underline}. Except as provided in paragraph (f)(5) of this
section, the allowable additional first year depreciation deduction for
qualified property is determined by multiplying the unadjusted
depreciable basis (as defined in §1.168(k)-1T(a)(2)(iii)) of the
qualified property by 30 percent. Except as provided in paragraph (f)(5)
of this section, the allowable additional first year depreciation
deduction for 50-percent bonus depreciation property is determined by
multiplying the unadjusted depreciable basis (as defined in
§1.168(k)-1T(a)(2)(iii)) of the 50-percent bonus depreciation property
by 50 percent. Except as provided in paragraph (f)(1) of this section,
the 30-percent or 50-percent additional first year depreciation
deduction is not affected by a taxable year of less than 12 months. See
paragraph (f)(1) of this section for qualified property or 50-percent
bonus depreciation property placed in service and disposed of in the
same taxable year. See paragraph (f)(5) of this section for qualified
property or 50-percent bonus depreciation property acquired in a
like-kind exchange or as a result of an involuntary conversion.

\(ii\) [Property having a longer production period]{.underline}. For
purposes of paragraph (d)(1)(i) of this section, the unadjusted
depreciable basis (as defined in §1.168(k)-1T(a)(2)(iii)) of qualified
property or 50-percent bonus depreciation property described in section
168(k)(2)(B) is limited to the property's unadjusted depreciable basis
attributable to the property's manufacture, construction, or production
after September 10, 2001 (for qualified property), or May 5, 2003 (for
50-percent bonus depreciation property), and before January 1, 2005.

\(iii\) [Alternative minimum tax]{.underline}. The 30-percent or
50-percent additional first year depreciation deduction is allowed for
alternative minimum tax purposes for the taxable year in which the
qualified property or the 50-percent bonus depreciation property is
placed in service by the taxpayer. The 30-percent or 50-percent
additional first year depreciation deduction for alternative minimum tax
purposes is based on the unadjusted depreciable basis of the property
for alternative minimum tax purposes.

\(2\) [Otherwise allowable depreciation deduction]{.underline}. Before
determining the amount otherwise allowable as a depreciation deduction
for the qualified property or the 50-percent bonus depreciation property
for the placed-in-service year and any subsequent taxable year, the
taxpayer must determine the remaining adjusted depreciable basis of the
qualified property or the 50-percent bonus depreciation property. This
remaining adjusted depreciable basis is equal to the unadjusted
depreciable basis of the qualified property or the 50-percent bonus
depreciation property reduced by the amount of the additional first year
depreciation allowed or allowable, whichever is greater. The remaining
adjusted depreciable basis of the qualified property or the 50-percent
bonus depreciation property is then depreciated using the applicable
depreciation provisions under the Internal Revenue Code for the
qualified property or the 50-percent bonus depreciation property. The
remaining adjusted depreciable basis of the qualified property or the
50-percent bonus depreciation property that is MACRS property is also
the basis to which the annual depreciation rates in the optional
depreciation tables apply (for further guidance, see section 8 of Rev.
Proc. 87-57 (1987-2 C.B. 687) and §601.601(d)(2)(ii)([b]{.underline}) of
this chapter). The depreciation deduction allowable for the remaining
adjusted depreciable basis of the qualified property or the 50-percent
bonus depreciation property is affected by a taxable year of less than
12 months.

\(ii\) [Alternative minimum tax]{.underline}. For alternative minimum
tax purposes, the depreciation deduction allowable for the remaining
adjusted depreciable basis of the qualified property or the 50-percent
bonus depreciation property is based on the remaining adjusted
depreciable basis for alternative minimum tax purposes. The remaining
adjusted depreciable basis of the qualified property or the 50-percent
bonus depreciable property for alternative minimum tax purposes is
depreciated using the same depreciation method, recovery period (or
useful life in the case of computer software), and convention that apply
to the qualified property or the 50-percent bonus depreciation property
for regular tax purposes.

\(3\) [Examples]{.underline}. This paragraph (d) is illustrated by the
following examples:

[Example 1]{.underline}. On March 1, 2003, [V]{.underline}, a
calendar-year taxpayer, purchased and placed in service qualified
property that costs \$1 million and is 5-year property under section
168(e). [V]{.underline} depreciates its 5-year property placed in
service in 2003 using the optional depreciation table that corresponds
with the general depreciation system, the 200-percent declining balance
method, a 5-year recovery period, and the half-year convention. For
2003, [V]{.underline} is allowed a 30-percent additional first year
depreciation deduction of \$300,000 (the unadjusted depreciable basis of
\$1 million multiplied by .30). Next, [V]{.underline} must reduce the
unadjusted depreciable basis of \$1 million by the additional first year
depreciation deduction of \$300,000 to determine the remaining adjusted
depreciable basis of \$700,000. Then, [V]{.underline}'s depreciation
deduction allowable in 2003 for the remaining adjusted depreciable basis
of \$700,000 is \$140,000 (the remaining adjusted depreciable basis of
\$700,000 multiplied by the annual depreciation rate of .20 for recovery
year 1).

[Example 2]{.underline}. On June 1, 2003, [W]{.underline}, a
calendar-year taxpayer, purchased and placed in service 50-percent bonus
depreciation property that costs \$126,000. The property qualifies for
the expensing election under section 179 and is 5-year property under
section 168(e). [W]{.underline} did not purchase any other section 179
property in 2003. [W]{.underline} makes the election under section 179
for the property and depreciates its 5-year property placed in service
in 2003 using the optional depreciation table that corresponds with the
general depreciation system, the 200-percent declining balance method, a
5-year recovery period, and the half-year convention. For 2003,
[W]{.underline} is first allowed a \$100,000 deduction under section
179. Next, [W]{.underline} must reduce the cost of \$126,000 by the
section 179 deduction of \$100,000 to determine the unadjusted
depreciable basis of \$26,000. Then, for 2003, [W]{.underline} is
allowed a 50-percent additional first year depreciation deduction of
\$13,000 (the unadjusted depreciable basis of \$26,000 multiplied by
.50). Next, [W]{.underline} must reduce the unadjusted depreciable basis
of \$26,000 by the additional first year depreciation deduction of
\$13,000 to determine the remaining adjusted depreciable basis of
\$13,000. Then, [W]{.underline}'s depreciation deduction allowable in
2003 for the remaining adjusted depreciable basis of \$13,000 is \$2,600
(the remaining adjusted depreciable basis of \$13,000 multiplied by the
annual depreciation rate of .20 for recovery year 1).

\(e\) [Election not to deduct additional first year
depreciation]{.underline}\--(1) [In general]{.underline}. If a taxpayer
makes an election under this paragraph (e), the election applies to all
qualified property or 50-percent bonus depreciation property, as
applicable, that is in the same class of property and placed in service
in the same taxable year. The rules of this paragraph (e) apply to the
following elections provided under section 168(k):

\(i\) [Qualified property]{.underline}. A taxpayer may make an election
not to deduct the 30-percent additional first year depreciation for any
class of property that is qualified property placed in service during
the taxable year. If this election is made, no additional first year
depreciation deduction is allowable for the property placed in service
during the taxable year in the class of property.

\(ii\) [50-percent bonus depreciation property]{.underline}. For any
class of property that is 50-percent bonus depreciation property placed
in service during the taxable year, a taxpayer may make an election\--

\(A\) To deduct the 30-percent, instead of the 50-percent, additional
first year depreciation. If this election is made, the allowable
additional first year depreciation deduction is determined as though the
class of property is qualified property under section 168(k)(2); or

\(B\) Not to deduct any additional first year depreciation. If this
election is made, no additional first year depreciation deduction is
allowable for the class of property.

\(2\) [Definition of class of property]{.underline}. For purposes of
this paragraph (e), the term class of property means:

\(i\) Except for the property described in paragraphs (e)(2)(ii) and
(iv) of this section, each class of property described in section 168(e)
(for example, 5-year property);

\(ii\) Water utility property as defined in section 168(e)(5) and
depreciated under section 168;

\(iii\) Computer software as defined in, and depreciated under, section
167(f)(1) and the regulations thereunder; or

\(iv\) Qualified leasehold improvement property as defined in paragraph
(c) of this section and depreciated under section 168.

\(3\) [Time and manner for making election]{.underline}\--(i) [Time for
making election]{.underline}. Except as provided in paragraph (e)(4) of
this section, any election specified in paragraph (e)(1) of this section
must be made by the due date (including extensions) of the Federal tax
return for the taxable year in which the qualified property or the
50-percent bonus depreciation property, as applicable, is placed in
service by the taxpayer.

\(ii\) [Manner of making election]{.underline}. Except as provided in
paragraph (e)(4) of this section, any election specified in paragraph
(e)(1) of this section must be made in the manner prescribed on Form
4562, "Depreciation and Amortization," and its instructions. The
election is made separately by each person owning qualified property or
50-percent bonus depreciation property (for example, for each member of
a consolidated group by the common parent of the group, by the
partnership, or by the S corporation). If Form 4562 is revised or
renumbered, any reference in this section to that form shall be treated
as a reference to the revised or renumbered form.

\(4\) [Special rules for 2000 or 2001 returns]{.underline}. For the
election specified in paragraph (e)(1)(i) of this section for qualified
property placed in service by the taxpayer during the taxable year that
included September 11, 2001, the taxpayer should refer to the guidance
provided by the Internal Revenue Service for the time and manner of
making this election on the 2000 or 2001 Federal tax return for the
taxable year that included September 11, 2001 (for further guidance, see
sections 3.03(3) and 4 of Rev. Proc. 2002-33 (2002-1 C.B. 963), Rev.
Proc. 2003-50 (2003-29 I.R.B. 119), and
§601.601(d)(2)(ii)([b]{.underline}) of this chapter).

\(5\) [Failure to make election]{.underline}. If a taxpayer does not
make the applicable election specified in paragraph (e)(1) of this
section within the time and in the manner prescribed in paragraph (e)(3)
or (4) of this section, the amount of depreciation allowable for that
property under section 167(f)(1) or under section 168, as applicable,
must be determined for the placed-in-service year and for all subsequent
taxable years by taking into account the additional first year
depreciation deduction. Thus, any election specified in paragraph (e)(1)
of this section shall not be made by the taxpayer in any other manner
(for example, the election cannot be made through a request under
section 446(e) to change the taxpayer=s method of accounting).

\(f\) [Special rules]{.underline}\--(1) [Property placed in service and
disposed of in the same taxable year]{.underline}\--(i) [In
general]{.underline}. Except as provided in paragraphs (f)(1)(ii) and
(iii) of this section, the additional first year depreciation deduction
is not allowed for qualified property or 50-percent bonus depreciation
property placed in service and disposed of during the same taxable year.

\(ii\) [Technical termination of a partnership]{.underline}. In the case
of a technical termination of a partnership under section 708(b)(1)(B),
the additional first year depreciation deduction is allowable for any
qualified property or 50-percent bonus depreciation property placed in
service by the terminated partnership during the taxable year of
termination and contributed by the terminated partnership to the new
partnership. The allowable additional first year depreciation deduction
for the qualified property or the 50-percent bonus depreciation property
shall not be claimed by the terminated partnership but instead shall be
claimed by the new partnership for the new partnership's taxable year in
which the qualified property or the 50-percent bonus depreciation
property was contributed by the terminated partnership to the new
partnership. However, if qualified property or 50-percent bonus
depreciation property is both placed in service and contributed to a new
partnership in a transaction described in section 708(b)(1)(B) by the
terminated partnership during the taxable year of termination, and if
such property is disposed of by the new partnership in the same taxable
year the new partnership received such property from the terminated
partnership, then no additional first year depreciation deduction is
allowable to either partnership.

\(iii\) [Section 168(i)(7) transactions]{.underline}. If any qualified
property or 50-percent bonus depreciation property is transferred in a
transaction described in section 168(i)(7) in the same taxable year that
the qualified property or the 50-percent bonus depreciation property is
placed in service by the transferor, the additional first year
depreciation deduction is allowable for the qualified property or the
50-percent bonus depreciation property. The allowable additional first
year depreciation deduction for the qualified property or the 50-percent
bonus depreciation property for the transferor's taxable year in which
the property is placed in service is allocated between the transferor
and the transferee on a monthly basis. This allocation shall be made in
accordance with the rules in §1.168(d)-1(b)(7)(ii) for allocating the
depreciation deduction between the transferor and the transferee.
However, if qualified property or 50-percent bonus depreciation property
is both placed in service and transferred in a transaction described in
section 168(i)(7) by the transferor during the same taxable year, and if
such property is disposed of by the transferee (other than by a
transaction described in section 168(i)(7)) during the same taxable year
the transferee received such property from the transferor, then no
additional first year depreciation deduction is allowable to either
party.

\(iv\) [Examples]{.underline}. The application of this paragraph (f)(1)
is illustrated by the

following examples:

[Example 1]{.underline}. [X]{.underline} and [Y]{.underline} are equal
partners in [Partnership XY]{.underline}, a general partnership. On
February 1, 2002, [Partnership XY]{.underline} purchased and placed in
service new equipment at a cost of \$30,000. On March 1, 2002,
[X]{.underline} sells its entire 50 percent interest to [Z]{.underline}
in a transfer that terminates the partnership under section
708(b)(1)(B). As a result, terminated [Partnership XY]{.underline} is
deemed to have contributed the equipment to new [Partnership
XY]{.underline}. Pursuant to paragraph (f)(1)(ii) of this section, new
[Partnership XY]{.underline}, not terminated [Partnership
XY]{.underline}, is eligible to claim the 30-percent additional first
year depreciation deduction allowable for the equipment for the taxable
year 2002 (assuming all other requirements are met).

[Example 2]{.underline}. On January 5, 2002, [BB]{.underline} purchased
and placed in service new office desks for a total amount of \$8,000. On
August 20, 2002, [BB]{.underline} transferred the office desks to
[Partnership BC]{.underline} in a transaction described in section 721.
[BB]{.underline} and [Partnership BC]{.underline} are calendar-year
taxpayers. Because the transaction between [BB]{.underline} and
[Partnership BC]{.underline} is a transaction described in section
168(i)(7), pursuant to paragraph (f)(1)(iii) of this section the
30-percent additional first year depreciation deduction allowable for
the desks is allocated between [BB]{.underline} and [Partnership
BC]{.underline} in accordance with the rules in §1.168(d)-1(b)(7)(ii)
for allocating the depreciation deduction between the transferor and the
transferee. Accordingly, the 30-percent additional first year
depreciation deduction allowable for the desks for 2002 of \$2,400 (the
unadjusted depreciable basis of \$8,000 multiplied by .30) is allocated
between [BB]{.underline} and [Partnership BC]{.underline} based on the
number of months that [BB]{.underline} and [Partnership BC]{.underline}
held the desks in service. Thus, because the desks were held in service
by [BB]{.underline} for 7 of 12 months, which includes the month in
which [BB]{.underline} placed the desks in service but does not include
the month in which the desks were transferred, [BB]{.underline} is
allocated \$1,400 (7/12 x \$2,400 additional first year depreciation
deduction). [Partnership BC]{.underline} is allocated \$1,000, the
remaining 5/12 of the \$2,400 additional first year depreciation
deduction allowable for the desks.

\(2\) [Redetermination of basis]{.underline}. If the unadjusted
depreciable basis (as defined in §1.168(k)-1T(a)(2)(iii)) of qualified
property or 50-percent bonus depreciation property is redetermined (for
example, due to contingent purchase price or discharge of indebtedness)
by January 1, 2005 (or January 1, 2006, for property described in
section 168(k)(2)(B)), the additional first year depreciation deduction
allowable for the qualified property or the 50-percent bonus
depreciation property is redetermined as follows:

\(i\) [Increase in basis]{.underline}. For the taxable year in which an
increase in basis of qualified property or 50-percent bonus depreciation
property occurs, the taxpayer shall claim an additional first year
depreciation deduction for qualified property by multiplying the amount
of the increase in basis for this property by 30 percent or, for
50-percent bonus depreciation property, by multiplying the amount of the
increase in basis for this property by 50 percent. For purposes of this
paragraph (f)(2)(i), the 30-percent additional first year depreciation
deduction applies to the increase in basis if the underlying property is
qualified property and the 50-percent additional first year depreciation
deduction applies to the increase in basis if the underlying property is
50-percent bonus depreciation property. To determine the amount
otherwise allowable as a depreciation deduction for the increase in
basis of qualified property or 50-percent bonus depreciation property,
the amount of the increase in basis of the qualified property or the
50-percent bonus depreciation property must be reduced by the additional
first year depreciation deduction allowed or allowable, whichever is
greater, for the increase in basis and the remaining increase in basis
of\--

\(A\) Qualified property or 50-percent bonus depreciation property
(except for computer software described in paragraph (b)(2)(i)(B) of
this section) is depreciated over the recovery period of the qualified
property or the 50-percent bonus depreciation property, as applicable,
remaining as of the beginning of the taxable year in which the increase
in basis occurs, and using the same depreciation method and convention
applicable to the qualified property or 50-percent bonus depreciation
property, as applicable, that applies for the taxable year in which the
increase in basis occurs; and

\(B\) Computer software (as defined in paragraph (b)(2)(i)(B) of this
section) that is qualified property or 50-percent bonus depreciation
property is depreciated ratably over the remainder of the 36-month
period (the useful life under section 167(f)(1)) as of the beginning of
the first day of the month in which the increase in basis occurs.

\(ii\) [Decrease in basis]{.underline}. For the taxable year in which a
decrease in basis of qualified property or 50-percent bonus depreciation
property occurs, the taxpayer shall include in the taxpayer's income the
excess additional first year depreciation deduction previously claimed
for the qualified property or the 50-percent bonus depreciation
property. This excess additional first year depreciation deduction for
qualified property is determined by multiplying the amount of the
decrease in basis for this property by 30 percent. The excess additional
first year depreciation deduction for 50-percent bonus depreciation
property is determined by multiplying the amount of the decrease in
basis for this property by 50 percent. For purposes of this paragraph
(f)(2)(ii), the 30-percent additional first year depreciation deduction
applies to the decrease in basis if the underlying property is qualified
property and the 50-percent additional first year depreciation deduction
applies to the decrease in basis if the underlying property is
50-percent bonus depreciation property. Also, if the taxpayer
establishes by adequate records or other sufficient evidence that the
taxpayer claimed less than the additional first year depreciation
deduction allowable for the qualified property or the 50-percent bonus
depreciation property before the decrease in basis or if the taxpayer
claimed more than the additional first year depreciation deduction
allowable for the qualified property or the 50-percent bonus
depreciation property before the decrease in basis, the excess
additional first year depreciation deduction is determined by
multiplying the amount of the decrease in basis by the additional first
year depreciation deduction percentage actually claimed by the taxpayer
for the qualified property or the 50-percent bonus depreciation
property, as applicable, before the decrease in basis. To determine the
amount includible in the taxpayer's income for the excess depreciation
previously claimed (other than the additional first year depreciation
deduction) resulting from the decrease in basis of the qualified
property or the 50-percent bonus depreciation property, the amount of
the decrease in basis of the qualified property or the 50-percent bonus
depreciation property must be adjusted by the excess additional first
year depreciation deduction includible in the taxpayer's income (as
determined under this paragraph) and the remaining decrease in basis
of\--

\(A\) Qualified property or 50-percent bonus depreciation property
(except for computer software described in paragraph (b)(2)(i)(B) of
this section) is included in the taxpayer's income over the recovery
period of the qualified property or the 50-percent bonus depreciation
property, as applicable, remaining as of the beginning of the taxable
year in which the decrease in basis occurs, and using the same
depreciation method and convention of the qualified property or
50-percent bonus depreciation property, as applicable, that applies in
the taxable year in which the decrease in basis occurs; and

\(B\) Computer software (as defined in paragraph (b)(2)(i)(B) of this
section) that is qualified property or 50-percent bonus depreciation
property is included in the taxpayer's income ratably over the remainder
of the 36-month period (the useful life under section 167(f)(1)) as of
the beginning of the first day of the month in which the decrease in
basis occurs.

\(iii\) [Definition]{.underline}. For purposes of this paragraph
(f)(2)\--

\(A\) An increase in basis occurs in the taxable year an amount is taken
into account under section 461; and

\(B\) A decrease in basis occurs in the taxable year an amount would be
taken into account under section 451.

\(iv\) [Examples]{.underline}. The application of this paragraph (f)(2)
is illustrated by the

following examples:

[Example 1]{.underline}. (i) On May 15, 2002, [CC]{.underline}, a
cash-basis taxpayer, purchased and placed in service qualified property
that is 5-year property at a cost of \$200,000. In addition to the
\$200,000, [CC]{.underline} agrees to pay the seller 25 percent of the
gross profits from the operation of the property in 2002. On May 15,
2003, [CC]{.underline} paid to the seller an additional \$10,000.
[CC]{.underline} depreciates the 5-year property placed in service in
2002 using the optional depreciation table that corresponds with the
general depreciation system, the 200-percent declining balance method, a
5-year recovery period, and the half-year convention.

\(ii\) For 2002, [CC]{.underline} is allowed a 30-percent additional
first year depreciation deduction of \$60,000 (the unadjusted
depreciable basis of \$200,000 multiplied by .30). In addition,
[CC]{.underline}'s depreciation deduction for 2002 for the remaining
adjusted depreciable basis of \$140,000 (the unadjusted depreciable
basis of \$200,000 reduced by the additional first year depreciation
deduction of \$60,000) is \$28,000 (the remaining adjusted depreciable
basis of \$140,000 multiplied by the annual depreciation rate of .20 for
recovery year 1).

\(iii\) For 2003, [CC]{.underline}'s depreciation deduction for the
remaining adjusted depreciable basis of \$140,000 is \$44,800 (the
remaining adjusted depreciable basis of \$140,000 multiplied by the
annual depreciation rate of .32 for recovery year 2). In addition,
pursuant to paragraph (f)(2)(i) of this section, [CC]{.underline} is
allowed an additional first year depreciation deduction for 2003 for the
\$10,000 increase in basis of the qualified property. Consequently,
[CC]{.underline} is allowed an additional first year depreciation
deduction of \$3,000 (the increase in basis of \$10,000 multiplied by
.30). Also, [CC]{.underline} is allowed a depreciation deduction for
2003 attributable to the remaining increase in basis of \$7,000 (the
increase in basis of \$10,000 reduced by the additional first year
depreciation deduction of \$3,000). The depreciation deduction allowable
for 2003 attributable to the remaining increase in basis of \$7,000 is
\$3,111 (the remaining increase in basis of \$7,000 multiplied by .4444,
which is equal to 1/remaining recovery period of 4.5 years at January 1,
2003, multiplied by 2). Accordingly, for 2003, [CC]{.underline}'s total
depreciation deduction allowable for the qualified property is \$50,911.

[Example 2]{.underline}. (i) On May 15, 2002, [DD]{.underline} purchased
and placed in service qualified property that is 5-year property at a
cost of \$400,000. To purchase the property, [DD]{.underline} borrowed
\$250,000 from Bank2. On May 15, 2003, Bank2 forgives \$50,000 of the
indebtedness. [DD]{.underline} makes the election provided in section
108(b)(5) to apply any portion of the reduction under section 1017 to
the basis of the depreciable property of the taxpayer. [DD]{.underline}
depreciates the 5-year property placed in service in 2002 using the
optional depreciation table that corresponds with the general
depreciation system, the 200-percent declining balance method, a 5-year
recovery period, and the half-year convention.

\(ii\) For 2002, [DD]{.underline} is allowed a 30-percent additional
first year depreciation deduction of \$120,000 (the unadjusted
depreciable basis of \$400,000 multiplied by .30). In addition,
[DD]{.underline}'s depreciation deduction allowable for 2002 for the
remaining adjusted depreciable basis of \$280,000 (the unadjusted
depreciable basis of \$400,000 reduced by the additional first year
depreciation deduction of \$120,000) is \$56,000 (the remaining adjusted
depreciable basis of \$280,000 multiplied by the annual depreciation
rate of .20 for recovery year 1).

\(iii\) For 2003, [DD]{.underline}'s deduction for the remaining
adjusted depreciable basis of \$280,000 is \$89,600 (the remaining
adjusted depreciable basis of \$280,000 multiplied by the annual
depreciation rate of .32 for recovery year 2). However, pursuant to
paragraph (f)(2)(ii) of this section, [DD]{.underline} must include in
its taxable income for 2003 the excess depreciation previously claimed
for the \$50,000 decrease in basis of the qualified property.
Consequently, [DD]{.underline} must include in its taxable income for
2003 the excess additional first year depreciation of \$4,500 (the
decrease in basis of \$50,000 multiplied by .30). Also, [DD]{.underline}
must include in its taxable income for 2003 the excess depreciation
attributable to the remaining decrease in basis of \$45,500 (the
decrease in basis of \$50,000 reduced by the excess additional first
year depreciation of \$4,500). The amount includible in taxable income
for 2003 for the remaining decrease in basis of \$45,500 is \$20,222
(the remaining decrease in basis of \$45,500 multiplied by .4444, which
is equal to 1/remaining recovery period of 4.5 years at January 1, 2003,
multiplied by 2). Accordingly, for 2003, [DD]{.underline}'s total
depreciation deduction allowable for the qualified property is \$64,878
(\$89,600 minus \$4,500 minus \$20,222).

\(3\) [Section 1245 and 1250 depreciation recapture]{.underline}. For
purposes of section 1245 and the regulations thereunder, the additional
first year depreciation deduction is an amount allowed or allowable for
depreciation. Further, for purposes of section 1250(b) and the
regulations thereunder, the additional first year depreciation deduction
is not a straight line method.

\(4\) [Coordination with section 169]{.underline}. The additional first
year depreciation deduction is allowable in the placed-in-service year
of a certified pollution control facility (as defined in §1.169-2(a))
that is qualified property or 50-percent bonus depreciation property,
even if the taxpayer makes the election to amortize the certified
pollution control facility under section 169 and the regulations
thereunder in the certified pollution control facility's
placed-in-service year.

\(5\) [Like-kind exchanges and involuntary
conversions]{.underline}\--(i) [Scope]{.underline}. The rules of this
paragraph (f)(5) apply to acquired MACRS property or acquired computer
software that is eligible for the additional first year depreciation
deduction under section 168(k) at the time of replacement provided the
time of replacement is after September 10, 2001, and before January 1,
2005, or, in the case of acquired MACRS property or acquired computer
software that is qualified property, or 50-percent bonus depreciation
property, described in section 168(k)(2)(B), the time of replacement is
after September 10, 2001, and before January 1, 2006.

\(ii\) [Definitions]{.underline}. For purposes of this paragraph (f)(5),
the following definitions apply:

\(A\) [Acquired MACRS property]{.underline} is MACRS property in the
hands of the acquiring taxpayer that is acquired in a transaction
described in section 1031(a), (b), or (c) for other MACRS property or
that is acquired in connection with an involuntary conversion of other
MACRS property in a transaction to which section 1033 applies.

\(B\) [Exchanged or involuntarily converted MACRS property]{.underline}
is MACRS property that is transferred by the taxpayer in a transaction
described in section 1031(a), (b), or (c), or that is converted as a
result of an involuntary conversion to which section 1033 applies.

\(C\) [Acquired computer software]{.underline} is computer software (as
defined in paragraph (b)(2)(i)(B) of this section) in the hands of the
acquiring taxpayer that is acquired in a like-kind exchange under
section 1031 or as a result of an involuntary conversion under section
1033.

\(D\) [Exchanged or involuntarily converted computer
software]{.underline} is computer software (as defined in paragraph
(b)(2)(i)(B) of this section) that is transferred by the taxpayer in a
like-kind exchange under section 1031 or that is converted as a result
of an involuntary conversion under section 1033.

\(E\) [Time of disposition]{.underline} is when the disposition of the
exchanged or involuntarily converted MACRS property or the exchanged or
involuntarily converted computer software, as applicable, takes place.

\(F\) [Time of replacement]{.underline} is the later of:

([1]{.underline}) when the property received in the exchange or
involuntary conversion is placed in service; or

([2]{.underline}) the time of disposition of involuntarily converted
property.

\(G\) [Carryover basis]{.underline} is the lesser of:

([1]{.underline}) the basis in the acquired MACRS property or acquired
computer software, as applicable and as determined under section 1031(d)
or 1033(b) and the regulations thereunder; or

([2]{.underline}) the adjusted depreciable basis of the exchanged or
involuntarily converted MACRS property or the exchanged or involuntarily
converted computer software, as applicable.

\(H\) [Excess basis]{.underline} is any excess of the basis in the
acquired MACRS property or acquired computer software, as applicable and
as determined under section 1031(d) or 1033(b) and the regulations
thereunder, over the carryover basis as determined under paragraph
(f)(5)(ii)(G) of this section.

\(I\) [Remaining carryover basis]{.underline} is the carryover basis as
determined under paragraph (f)(5)(ii)(G) of this section reduced by\--

([1]{.underline}) The percentage of the taxpayer\'s use of property for
the taxable year other than in the taxpayer\'s trade or business (or for
the production of income); and

([2]{.underline}) Any adjustments to basis provided by other provisions
of the Code and the regulations thereunder (including section 1016(a)(2)
and (3)) for periods prior to the disposition of the exchanged or
involuntarily converted property.

\(J\) [Remaining excess basis]{.underline} is the excess basis as
determined under paragraph (f)(5)(ii)(H) of this section reduced by\--

([1]{.underline}) The percentage of the taxpayer\'s use of property for
the taxable year other than in the taxpayer\'s trade or business (or for
the production of income);

([2]{.underline}) Any portion of the basis the taxpayer properly elects
to treat as an expense under section 179; and

([3]{.underline}) Any adjustments to basis provided by other provisions
of the Code and the regulations thereunder.

\(iii\) [Computation]{.underline}\--(A) [In general]{.underline}.
Assuming all other requirements are met, the remaining carryover basis
for the year of replacement and the remaining excess basis, if any, for
the year of replacement for the acquired MACRS property or the acquired
computer software, as applicable, are eligible for the additional first
year depreciation deduction. The 30-percent additional first year
depreciation deduction applies to the remaining carryover basis and the
remaining excess basis, if any, of the acquired MACRS property or the
acquired computer software if the time of replacement is after September
10, 2001, and before May 6, 2003, or if the taxpayer made the election
provided in paragraph (e)(1)(ii)(A) of this section. The 50-percent
additional first year depreciation deduction applies to the remaining
carryover basis and the remaining excess basis, if any, of the acquired
MACRS property or the acquired computer software if the time of
replacement is after May 5, 2003, and before January 1, 2005, or before
January 1, 2006, for 50-percent bonus depreciation property described in
section 168(k)(2)(B). The additional first year depreciation deduction
is computed separately for the remaining carryover basis and the
remaining excess basis. Rules similar to the rules provided in paragraph
(d) of this section apply to property described in section 168(k)(2)(B)
and for alternative minimum tax purposes.

\(B\) [Year of disposition and year of replacement]{.underline}. The
additional first year depreciation deduction is allowable for the
acquired MACRS property or acquired computer software in the year of
replacement. However, the additional first year depreciation deduction
is not allowable for the exchanged or involuntarily converted MACRS
property or the exchanged or involuntarily converted computer software
if the MACRS property or computer software, as applicable, is placed in
service and disposed of in an exchange or involuntary conversion in the
same taxable year.

\(iv\) [Sale-leaseback transaction]{.underline}. For purposes of this
paragraph (f)(5), if MACRS property or computer software is sold to a
taxpayer and leased back to a person by the taxpayer within three months
after the time of disposition of the MACRS property or computer
software, as applicable, the time of replacement for this MACRS property
or computer software, as applicable, shall not be earlier than the date
on which the MACRS property or computer software, as applicable, is used
by the lessee under the leaseback.

\(v\) [Examples]{.underline}. The application of this paragraph (f)(5)
is illustrated by the following examples:

[Example 1]{.underline}. (i) In December 2002, [EE]{.underline}, a
calendar-year corporation, acquired for \$200,000 and placed in service
Canopy V1, a gas station canopy. Canopy V1 is qualified property under
section 168(k)(1) and is 5-year property under section 168(e).
[EE]{.underline} depreciated Canopy V1 under the general depreciation
system of section 168(a) by using the 200-percent declining balance
method of depreciation, a 5-year recovery period, and the half-year
convention. [EE]{.underline} elected to use the optional depreciation
tables to compute the depreciation allowance for Canopy V1. On January
1, 2003, Canopy V1 was destroyed in a fire and was no longer usable in
[EE]{.underline}'s business. On June 1, 2003, in a transaction described
in section 1033(a)(2), [EE]{.underline} acquired and placed in service
Canopy W1 with all of the \$160,000 of insurance proceeds
[EE]{.underline} received due to the loss of Canopy V1. Canopy W1 is
50-percent bonus depreciation property under section 168(k)(4) and is
5-year property under section 168(e).

\(ii\) For 2002, [EE]{.underline} is allowed a 30-percent additional
first year depreciation deduction of \$60,000 for Canopy V1 (the
unadjusted depreciable basis of \$200,000 multiplied by .30), and a
regular MACRS depreciation deduction of \$28,000 for Canopy V1 (the
remaining adjusted depreciable basis of \$140,000 multiplied by the
annual depreciation rate of .20 for recovery year 1).

\(iii\) Pursuant to paragraph (f)(5)(iii)(A) of this section, the
additional first year depreciation deduction allowable for Canopy W1
equals \$56,000 (.50 of Canopy W1's remaining carryover basis of
\$112,000 (Canopy V1's remaining adjusted depreciable basis of \$140,000
minus 2002 regular MACRS depreciation deduction of \$28,000).

[Example 2]{.underline}. (i) Same facts as in [Example 1]{.underline},
except [EE]{.underline} elected not to deduct the additional first year
depreciation for 5-year property placed in service in 2002.
[EE]{.underline} deducted the additional first year depreciation for
5-year property placed in service in 2003.

\(ii\) For 2002, [EE]{.underline} is allowed a regular MACRS
depreciation deduction of \$40,000 for Canopy V1 (the unadjusted
depreciable basis of \$200,000 multiplied by the annual depreciation
rate of .20 for recovery year 1).

\(iii\) Pursuant to paragraph (f)(5)(iii)(A) of this section, the
additional first year depreciation deduction allowable for Canopy W1
equals \$80,000 (.50 of Canopy W1's remaining carryover basis of
\$160,000 (Canopy V1's unadjusted depreciable basis of \$200,000 minus
2002 regular MACRS depreciation deduction of \$40,000) .

[Example 3]{.underline}. (i) In December 2001, [FF]{.underline}, a
calendar year corporation, acquired for \$10,000 and placed in service
Computer X2. Computer X2 is qualified property under section 168(k)(1)
and is 5-year property under section 168(e). [FF]{.underline}
depreciated Computer X2 under the general depreciation system of section
168(a) by using the 200-percent declining balance method of
depreciation, a 5-year recovery period, and the half-year convention.
[FF]{.underline} elected to use the optional depreciation tables to
compute the depreciation allowance for Computer X2. On January 1, 2002,
[FF]{.underline} acquired Computer Y2 by exchanging Computer X2 and
\$1,000 cash in a transaction described in section 1031(a). Computer Y2
is qualified property under section 168(k)(1) and is 5-year property
under section 168(e).

\(ii\) For 2001, [FF]{.underline} is allowed a 30-percent additional
first year depreciation deduction of \$3,000 for Computer X2 (unadjusted
basis of \$10,000 multiplied by .30), and a regular MACRS depreciation
deduction of \$1,400 for Computer X2 (the remaining adjusted depreciable
basis of \$7,000 multiplied by the annual depreciation rate of .20 for
recovery year 1).

\(iii\) Pursuant to paragraph (f)(5)(iii)(A) of this section, the
30-percent additional first year depreciation deduction for Computer Y2
is allowable for the remaining carryover basis of \$5,600 (Computer X2's
unadjusted depreciable basis of \$10,000 minus additional first year
depreciation deduction allowable of \$3,000 minus 2001 regular MACRS
depreciation deduction of \$1,400) and for the remaining excess basis of
\$1,000 (cash paid for Computer Y2). Thus, the 30-percent additional
first year depreciation deduction for the remaining carryover basis
equals \$1,680 (\$5,600 multiplied by .30) and for the remaining excess
basis equals \$300 (\$1,000 multiplied by .30), which totals \$1,980.

[Example 4]{.underline}. (i) In September 2002, [GG]{.underline}, a June
30 year-end corporation, acquired for \$20,000 and placed in service
Equipment X3. Equipment X3 is qualified property under section 168(k)(1)
and is 5-year property under section 168(e). [GG]{.underline}
depreciated Equipment X3 under the general depreciation system of
section 168(a) by using the 200-percent declining balance method of
depreciation, a 5-year recovery period, and the half-year convention.
[GG]{.underline} elected to use the optional depreciation tables to
compute the depreciation allowance for Equipment X3. In December 2002,
[GG]{.underline} acquired Equipment Y3 by exchanging Equipment X3 and
\$5,000 cash in a transaction described in section 1031(a). Equipment Y3
is qualified property under section 168(k)(1) and is 5-year property
under section 168(e).

\(ii\) Pursuant to paragraph (f)(5)(iii)(B) of this section, no
additional first year depreciation deduction is allowable for Equipment
X3 and, pursuant to §1.168(d)-1T(b)(3)(ii), no regular depreciation
deduction is allowable for Equipment X3.

\(iii\) Pursuant to paragraph (f)(5)(iii)(A) of this section, the
30-percent additional first year depreciation deduction for Equipment Y3
is allowable for the remaining carryover basis of \$20,000 (Equipment
X3's unadjusted depreciable basis of \$20,000) and for the remaining
excess basis of \$5,000 (cash paid for Equipment Y3). Thus, the
30-percent additional first year depreciation deduction for the
remaining carryover basis equals \$6,000 (\$20,000 multiplied by .30)
and for the remaining excess basis equals \$1,500 (\$5,000 multiplied by
.30), which totals \$7,500.

[Example 5]{.underline}. (i) Same facts as in [Example 4]{.underline}.
GG depreciated Equipment Y3 under the general depreciation system of
section 168(a) by using the 200-percent declining balance method of
depreciation, a 5-year recovery period, and the half-year convention.
[GG]{.underline} elected to use the optional depreciation tables to
compute the depreciation allowance for Equipment Y3. On July 1, 2003,
[GG]{.underline} acquired Equipment Z1 by exchanging Equipment Y3 in a
transaction described in section 1031(a). Equipment Z1 is 50-percent
bonus depreciation property under section 168(k)(4) and is 5-year
property under section 168(e).

\(ii\) For the taxable year ending June 30, 2003, the regular MACRS
depreciation deduction allowable for the remaining carryover basis of
Equipment Y3 is \$2,800 (the remaining carryover basis of \$14,000
multiplied by the annual depreciation rate of .20 for recovery year 1)
and for the remaining excess basis of Equipment Y3 is \$700 (the
remaining excess basis of \$3,500 multiplied by the annual depreciation
rate of .20 for recovery year 1), which totals \$3,500.

\(iii\) For the taxable year ending June 30, 2004, pursuant to paragraph
(f)(5)(iii)(A) of this section, the 50-percent additional first year
depreciation deduction allowable for Equipment Z1 is \$7,000 (.50 of
Equipment Z1's remaining carryover basis of \$14,000 (Equipment Y3's
total unadjusted depreciable basis of \$25,000 minus the total
additional first year depreciation deduction of \$7,500 minus the total
regular MACRS depreciation deduction of \$3,500).

\(6\) [Change in use]{.underline}\--(i) [Change in use of
depreciable]{.underline} [property]{.underline}. The determination of
whether the use of depreciable property changes is made in accordance
with section 168(i)(5) and regulations thereunder.

\(ii\) [Conversion to personal use]{.underline}. If qualified property
or 50-percent bonus depreciation property is converted from business or
income-producing use to personal use in the same taxable year in which
the property is placed in service by a taxpayer, the additional first
year depreciation deduction is not allowable for the property.

\(iii\) [Conversion to business or income-producing
use]{.underline}\--(A) [During the same taxable year]{.underline}. If,
during the same taxable year, property is acquired by a taxpayer for
personal use and is converted by the taxpayer from personal use to
business or income-producing use, the additional first year depreciation
deduction is allowable for the property in the taxable year the property
is converted to business or income-producing use (assuming all of the
requirements in paragraph (b) of this section are met). See paragraph
(b)(3)(ii) of this section relating to the original use rules for a
conversion of property to business or income-producing use.

\(B\) [Subsequent to the acquisition year]{.underline}. If property is
acquired by a taxpayer for personal use and, during a subsequent taxable
year, is converted by the taxpayer from personal use to business or
income-producing use, the additional first year depreciation deduction
is allowable for the property in the taxable year the property is
converted to business or income-producing use (assuming all of the
requirements in paragraph (b) of this section are met). For purposes of
paragraphs (b)(4) and (5) of this section, the property must be acquired
by the taxpayer for personal use after September 10, 2001 (for qualified
property), or after May 5, 2003 (for 50-percent bonus depreciation
property), and converted by the taxpayer from personal use to business
or income-producing use by January 1, 2005. See paragraph (b)(3)(ii) of
this section relating to the original use rules for a conversion of
property to business or income-producing use.

\(iv\) [Depreciable property changes use subsequent to the
placed-in-service year]{.underline}\--(A) If the use of qualified
property or 50-percent bonus depreciation property changes in the hands
of the same taxpayer subsequent to the taxable year the qualified
property or the 50-percent bonus depreciation property, as applicable,
is placed in service and, as a result of the change in use, the property
is no longer qualified property or 50-percent bonus depreciation
property, as applicable, the additional first year depreciation
deduction allowable for the qualified property or the 50-percent bonus
depreciation property, as applicable, is not redetermined.

\(B\) If depreciable property is not qualified property or 50-percent
bonus depreciation property in the taxable year the property is placed
in service by the taxpayer, the additional first year depreciation
deduction is not allowable for the property even if a change in the use
of the property subsequent to the taxable year the property is placed in
service results in the property being qualified property or 50-percent
bonus depreciation property in the taxable year of the change in use.

\(v\) [Examples]{.underline}. The application of this paragraph (f)(6)
is illustrated by the

following examples:

[Example 1]{.underline}. (i) On January 1, 2002, [HH]{.underline}, a
calendar year corporation, purchased and placed in service several new
computers at a total cost of \$100,000. [HH]{.underline} used these
computers within the United States for 3 months in 2002 and then moved
and used the computers outside the United States for the remainder of
2002. On January 1, 2003, [HH]{.underline} permanently returns the
computers to the United States for use in its business.

\(ii\) For 2002, the computers are considered as used predominantly
outside the United States in 2002 pursuant to §1.48-1(g)(1)(i). As a
result, the computers are required to be depreciated under the
alternative depreciation system of section 168(g). Pursuant to paragraph
(b)(2)(ii)(A)([2]{.underline}) of this section, the computers are not
qualified property in 2002, the placed-in-service year. Thus, pursuant
to (f)(6)(iv)(B) of this section, no additional first year depreciation
deduction is allowed for these computers, regardless of the fact that
the computers are permanently returned to the United States in 2003.

[Example 2]{.underline}. (i) On February 8, 2002, [II]{.underline}, a
calendar year corporation, purchased and placed in service new equipment
at a cost of \$1,000,000 for use in its California plant. The equipment
is 5-year property under section 168(e) and is qualified property under
section 168(k). [II]{.underline} depreciates its 5-year property placed
in service in 2002 using the optional depreciation table that
corresponds with the general depreciation system, the 200-percent
declining balance method, a 5-year recovery period, and the half-year
convention. On June 4, 2003, due to changes in [II]{.underline}'s
business circumstances, [II]{.underline} permanently moves the equipment
to its plant in Mexico.

\(ii\) For 2002, [II]{.underline} is allowed a 30-percent additional
first year depreciation deduction of \$300,000 (the adjusted depreciable
basis of \$1,000,000 multiplied by .30). In addition, [II]{.underline}'s
depreciation deduction allowable in 2002 for the remaining adjusted
depreciable basis of \$700,000 (the unadjusted depreciable basis of
\$1,000,000 reduced by the additional first year depreciation deduction
of \$300,000) is \$140,000 (the remaining adjusted depreciable basis of
\$700,000 multiplied by the annual depreciation rate of .20 for recovery
year 1).

\(iii\) For 2003, the equipment is considered as used predominantly
outside the United States pursuant to §1.48-1(g)(1)(i). As a result of
this change in use, the adjusted depreciable basis of \$560,000 for the
equipment is required to be depreciated under the alternative
depreciation system of section 168(g) beginning in 2003. However, the
additional first year depreciation deduction of \$300,000 allowed for
the equipment in 2002 is not redetermined.

\(7\) [Earnings and profits]{.underline}. The additional first year
depreciation deduction is not allowable for purposes of computing
earnings and profits.

\(8\) [Limitation of amount of depreciation for certain passenger
automobiles]{.underline}. For a passenger automobile as defined in
section 280F(d)(5), the limitation under section 280F(a)(1)(A)(i) is
increased by\--

\(i\) \$4,600 for qualified property acquired by a taxpayer after
September 10, 2001, and before May 6, 2003; and

\(ii\) \$7,650 for qualified property or 50-percent bonus depreciation
property acquired by a taxpayer after May 5, 2003.

\(9\) [Section 754 election]{.underline}. In general, for purposes of
section 168(k) any increase in basis of qualified property or 50-percent
bonus depreciation property due to a section 754 election is not
eligible for the additional first year depreciation deduction. However,
if qualified property or 50-percent bonus depreciation property is
placed in service by a partnership in the taxable year the partnership
terminates under section 708(b)(1)(B), any increase in basis of the
qualified property or the 50-percent bonus depreciation property due to
a section 754 election is eligible for the additional first year
depreciation deduction.

\(g\) [Effective date]{.underline}\--(1) [In general]{.underline}.
Except as provided in paragraphs (g)(2) and (3) of this section, this
section applies to qualified property under section 168(k)(2) acquired
by a taxpayer after September 10, 2001, and to 50-percent bonus
depreciation property under section 168(k)(4) acquired by a taxpayer
after May 5, 2003. This section expires on September 7, 2006.

\(2\) [Technical termination of a partnership or section 168(i)(7)
transactions]{.underline}. If qualified property or 50 percent bonus
depreciation property is transferred in a technical termination of a
partnership under section 708(b)(1)(B) or in a transaction described in
section 168(i)(7) for a taxable year ending on or before September 8,
2003, and the additional first year depreciation deduction allowable for
the property was not determined in accordance with paragraph (f)(1)(ii)
or (iii) of this section, as applicable, the Internal Revenue Service
will allow any reasonable method of determining the additional first
year depreciation deduction allowable for the property in the year of
the transaction that is consistently applied to the property by all
parties to the transaction.

\(3\) [Like-kind exchanges and involuntary conversions]{.underline}. If
a taxpayer did not claim on a federal tax return for a taxable year
ending on or before September 8, 2003, the additional first year
depreciation deduction for the remaining carryover basis of qualified
property or 50-percent bonus depreciation property acquired in a
transaction described in section 1031(a), (b), or (c), or in a
transaction to which section 1033 applies and the taxpayer did not make
an election not to deduct the additional first year depreciation
deduction for the class of property applicable to the remaining
carryover basis, the Internal Revenue Service will treat the taxpayer's
method of not claiming the additional first year depreciation deduction
for the remaining carryover basis as a permissible method of accounting
and will treat the amount of the additional first year depreciation
deduction allowable for the remaining carryover basis as being equal to
zero, provided the taxpayer does not claim the additional first year
depreciation deduction for the remaining carryover basis in accordance
with paragraph (g)(4)(ii) of this section.

\(4\) [Change in method of accounting]{.underline}\--(i) [Special rules
for 2000 or 2001 returns]{.underline}. If a taxpayer did not claim on
the Federal tax return for the taxable year that included September 11,
2001, any additional first year depreciation deduction for a class of
property that is qualified property and did not make an election not to
deduct the additional first year depreciation deduction for that class
of property, the taxpayer should refer to the guidance provided by the
Internal Revenue Service for the time and manner of claiming the
additional first year depreciation deduction for the class of property
(for further guidance, see section 4 of Rev. Proc. 2002-33 (2002-1 C.B.
963), Rev. Proc. 2003-50 (2003-29 I.R.B. 119), and
§601.601(d)(2)(ii)([b]{.underline}) of this chapter).

\(ii\) [Like-kind exchanges and involuntary conversions]{.underline}. If
a taxpayer did not claim on a federal tax return for any taxable year
ending on or before September 8, 2003, the additional first year
depreciation deduction allowable for the remaining carryover basis of
qualified property or 50-percent bonus depreciation property acquired in
a transaction described in section 1031(a), (b), or (c), or in a
transaction to which section 1033 applies and the taxpayer did not make
an election not to deduct the additional first year depreciation
deduction for the class of property applicable to the remaining
carryover basis, the taxpayer may claim the additional first year
depreciation deduction allowable for the remaining carryover basis in
accordance with paragraph (f)(5) of this section either:

\(A\) by filing an amended return (or a qualified amended return, if
applicable (for further guidance, see Rev. Proc. 94-69 (1994-2 C.B. 804)
and §601.601(d)(2)(ii)([b]{.underline}) of this chapter)) on or before
December 31, 2003, for the year of replacement and any affected
subsequent taxable year; or,

\(B\) by following the applicable administrative procedures issued under
§1.446-1(e)(3)(ii) for obtaining the Commissioner's automatic consent to
a change in method of accounting (for further guidance, see Rev. Proc.
2002-9 (2002-1 C.B. 327) and §601.601(d)(2)(ii)([b]{.underline}) of this
chapter).

Par. 8. Section 1.169-3 is amended by:

1\. Revising paragraphs (a) and (b)(2).

2\. Adding paragraph (g).

The additions and revisions read as follows:

[§1.169-3 Amortizable basis]{.underline}.

\* \* \* \* \*

\(a\) \[Reserved\]. For further guidance, see §1.169-3T(a).

\* \* \* \* \*

\(b\) \* \* \*

\(2\) \[Reserved\]. For further guidance, see §1.169-3T(b)(2).

\* \* \* \* \*

\(g\) [Effective date for qualified property, 50-percent bonus
depreciation property, and qualified New York Liberty Zone
property]{.underline}. \[Reserved\]. For further guidance, see
§1.169-3T(g).

Par. 9. Section 1.169-3T is added to read as follows:

[§1.169-3T Amortizable basis (temporary)]{.underline}.

\(a\) [In general]{.underline}. The amortizable basis of a certified
pollution control facility for the purpose of computing the amortization
deduction under section 169 is the adjusted basis of the facility for
purposes of determining gain (see part II (section 1011 and following),
subchapter O, chapter 1 of the Internal Revenue Code), as modified by
paragraphs (b), (c), and (d) of this section. The adjusted basis for
purposes of determining gain (computed without regard to these
modifications) of a facility that performs a function in addition to
pollution control, or that is used in connection with more than one
plant or other property, or both, is determined under §1.169-2(a)(3).
For rules as to additions and improvements to such a facility, see
paragraph (f) of this section. Before computing the amortization
deduction allowable under section 169, the adjusted basis for purposes
of determining gain for a facility that is placed in service by a
taxpayer after September 10, 2001, and that is qualified property under
section 168(k)(2) or §1.168(k)-1T, 50-percent bonus depreciation
property under section 168(k)(4) or §1.168(k)-1T, or qualified New York
Liberty Zone property under section 1400L(b) or §1.1400L(b)-1T must be
reduced by the amount of the additional first year depreciation
deduction allowed or allowable, whichever is greater, under section
168(k) or section 1400L(b), as applicable, for the facility.

\(b\) [Limitation on post-1968 construction, reconstruction, or
erection]{.underline}. (1) For further guidance, see §1.169-3(b)(1).

\(2\) If the taxpayer elects to begin the 60-month amortization period
with the first month of the taxable year succeeding the taxable year in
which the facility is completed or acquired and a depreciation deduction
is allowable under section 167 (including an additional first-year
depreciation allowance under former section 179; for a facility that is
acquired by the taxpayer after September 10, 2001, and that is qualified
property under section 168(k)(2) or §1.168(k)-1T or qualified New York
Liberty Zone property under section 1400L(b) or §1.1400L(b)-1T, the
additional first year depreciation deduction under section 168(k)(1) or
1400L(b), as applicable; and for a facility that is acquired by the
taxpayer after May 5, 2003, and that is 50-percent bonus depreciation
property under section 168(k)(4) or §1.168(k)-1T, the additional first
year depreciation deduction under section 168(k)(4)) with respect to the
facility for the taxable year in which it is completed or acquired, the
amount determined under paragraph (b)(1) of this section shall be
reduced by an amount equal to the amount of the depreciation deduction
allowed or allowable, whichever is greater, multiplied by a fraction the
numerator of which is the amount determined under paragraph (b)(1) of
this section, and the denominator of which is the facility's total cost.
The additional first-year allowance for depreciation under former
section 179 will be allowable only for the taxable year in which the
facility is completed or acquired and only if the taxpayer elects to
begin the amortization deduction under section 169 with the taxable year
succeeding the taxable year in which such facility is completed or
acquired. For a facility that is acquired by a taxpayer after September
10, 2001, and that is qualified property under section 168(k)(2) or
§1.168(k)-1T or qualified New York Liberty Zone property under section
1400L(b) or §1.1400L(b)-1T, see §1.168(k)-1T(f)(4) or
§1.1400L(b)-1T(f)(4), as applicable, with respect to when the additional
first year depreciation deduction under section 168(k)(1) or 1400L(b) is
allowable. For a facility that is acquired by a taxpayer after May 5,
2003, and that is 50-percent bonus depreciation property under section
168(k)(4) or §1.168(k)-1T, see §1.168(k)-1T(f)(4) with respect to when
the additional first year depreciation deduction under section 168(k)(4)
is allowable.

\(c\) through (f) For further guidance, see §1.169-3(c) through (f).

\(g\) [Effective date for qualified property, 50-percent bonus
depreciation property, and qualified New York Liberty Zone
property]{.underline}. This section applies to a certified pollution
control facility. This section also applies to a certified pollution
control facility that is qualified property under section 168(k)(2) or
qualified New York Liberty Zone property under section 1400L(b) acquired
by a taxpayer after September 10, 2001, and to a certified pollution
control facility that is 50-percent bonus depreciation property under
section 168(k)(4) acquired by a taxpayer after May 5, 2003. This section
expires on September 7, 2006.

Par. 10. Section 1.1400L(b)-1T is added to read as follows:

[§1.1400L(b)-1T Additional first year depreciation deduction for
qualified New York Liberty Zone property (temporary)]{.underline}.

\(a\) [Scope]{.underline}. This section provides the rules for
determining the 30-percent additional first year depreciation deduction
allowable under section 1400L(b) for qualified New York Liberty Zone
property.

\(b\) [Definitions]{.underline}. For purposes of section 1400L(b) and
this section, the definitions of the terms in §1.168(k)-1T(a)(2) apply
and the following definitions also apply:

\(1\) [Building]{.underline} and [structural components]{.underline}
have the same meanings as those terms are defined in §1.48-1(e).

\(2\) [New York Liberty Zone]{.underline} is the area located on or
south of Canal Street, East Broadway (east of its intersection with
Canal Street), or Grand Street (east of its intersection with East
Broadway) in the Borough of Manhattan in the City of New York, New York.

\(3\) [Nonresidential real property]{.underline} and [residential rental
property]{.underline} have the same meanings as those terms are defined
in section 168(e)(2).

\(4\) [Real property]{.underline} is a building or its structural
components, or other tangible real property except property described in
section 1245(a)(3)(B) (relating to depreciable property used as an
integral part of a specified activity or as a specified facility),
section 1245(a)(3)(D) (relating to single purpose agricultural or
horticultural structure), or section 1245(a)(3)(E) (relating to a
storage facility used in connection with the distribution of petroleum
or any primary product of petroleum).

\(c\) [Qualified New York Liberty Zone property]{.underline}\--(1) [In
general]{.underline}. Qualified New York Liberty Zone property is
depreciable property that\--

\(i\) Meets the requirements in §1.1400L(b)-1T(c)(2) (description of
property);

\(ii\) Meets the requirements in §1.1400L(b)-1T(c)(3) (substantial use);

\(iii\) Meets the requirements in §1.1400L(b)-1T(c)(4) (original use);

\(iv\) Meets the requirements in §1.1400L(b)-1T(c)(5) (acquisition of
property by purchase); and

\(v\) Meets the requirements in §1.1400L(b)-1T(c)(6) (placed-in-service
date).

\(2\) [Description of qualified New York Liberty Zone
property]{.underline}\--(i) [In general]{.underline}. Depreciable
property will meet the requirements of this paragraph (c)(2) if the
property is\--

\(A\) Described in §1.168(k)-1T(b)(2)(i); or

\(B\) Nonresidential real property or residential rental property
depreciated under section 168, but only to the extent it rehabilitates
real property damaged, or replaces real property destroyed or condemned,
as a result of the terrorist attacks of September 11, 2001. Property is
treated as replacing destroyed or condemned property if, as part of an
integrated plan, the property replaces real property that is included in
a continuous area that includes real property destroyed or condemned.
For purposes of this section, real property is considered as destroyed
or condemned only if an entire building or structure was destroyed or
condemned as a result of the terrorist attacks of September 11, 2001.
Otherwise, the real property is considered damaged real property. For
example, if certain structural components (for example, walls, floors,
and plumbing fixtures) of a building are damaged or destroyed as a
result of the terrorist attacks of September 11, 2001, but the building
is not destroyed or condemned, then only costs related to replacing the
damaged or destroyed structural components qualify under this paragraph
(c)(2)(i)(B).

\(ii\) [Property not eligible for additional first year depreciation
deduction]{.underline}. Depreciable property will not meet the
requirements of this paragraph (c)(2) if \--

\(A\) Section 168(k) or §1.168(k)-1T applies to the property; or

\(B\) The property is described in section §1.168(k)-1T(b)(2)(ii).

\(3\) [Substantial use]{.underline}. Depreciable property will meet the
requirements of this paragraph (c)(3) if substantially all of the use of
the property is in the New York Liberty Zone and is in the active
conduct of a trade or business by the taxpayer in New York Liberty Zone.
For purposes of this paragraph (c)(3), "substantially all" means 80
percent or more.

\(4\) [Original use]{.underline}. Depreciable property will meet the
requirements of this paragraph (c)(4) if the original use of the
property commences with the taxpayer in the New York Liberty Zone after
September 10, 2001. The original use rules in §1.168(k)-1T(b)(3) apply
for purposes of this paragraph (c)(4). In addition, used property will
satisfy the original use requirement in this paragraph (c)(4) so long as
the property has not been previously used within the New York Liberty
Zone.

\(5\) [Acquisition of property by purchase]{.underline}\--(i) [In
general]{.underline}. Depreciable property will meet the requirements of
this paragraph (c)(5) if the property is acquired by the taxpayer by
purchase (as defined in section 179(d) and §1.179-4(c)) after September
10, 2001, but only if no written binding contract for the acquisition of
the property was in effect before September 11, 2001. For purposes of
this paragraph (c)(5), the rules in §1.168(k)-1T(b)(4)(ii) (binding
contract), the rules in §1.168(k)-1T(b)(4)(iii) (self-constructed
property), and the rules in §1.168(k)-1T(b)(4)(iv) (disqualified
transactions) apply. For purposes of the preceding sentence, the rules
in § 1.168(k)-1T(b)(4)(iii) shall be applied without regard to 'and
before January 1, 2005.\'

\(ii\) [Exception for certain transactions]{.underline}. For purposes of
this section, the new partnership of a transaction described in
§1.168(k)-1T(f)(1)(ii) (technical termination of a partnership) or the
transferee of a transaction described in §1.168(k)-1T(f)(1)(iii)
(section 168(i)(7) transactions) is deemed to acquire the depreciable
property by purchase.

\(6\) [Placed-in-service date]{.underline}. Depreciable property will
meet the requirements of this paragraph (c)(6) if the property is placed
in service by the taxpayer on or before December 31, 2006. However,
nonresidential real property and residential rental property described
in paragraph (c)(2)(i)(B) of this section must be placed in service by
the taxpayer on or before December 31, 2009. The rules in
§1.168(k)-1T(b)(5)(ii) (relating to sale-leaseback and syndication
transactions), the rules in §1.168(k)-1T(b)(5)(iii) (relating to a
technical termination of a partnership under section 708(b)(1)(B)), and
the rules in §1.168(k)-1T(b)(5)(iv) (relating to section 168(i)(7)
transactions) apply for purposes of this paragraph (c)(6).

\(d\) [Computation of depreciation deduction for qualified New York
Liberty Zone property]{.underline}. The computation of the allowable
additional first year depreciation deduction and the otherwise allowable
depreciation deduction for qualified New York Liberty Zone property is
made in accordance with the rules for qualified property in
§1.168(k)-1T(d)(1)(i) and (2).

\(e\) [Election not to deduct additional first year
depreciation]{.underline}\--(1) [In general]{.underline}. A taxpayer may
make an election not to deduct the 30-percent additional first year
depreciation for any class of property that is qualified New York
Liberty Zone property placed in service during the taxable year. If a
taxpayer makes an election under this paragraph (e), the election
applies to all qualified New York Liberty Zone property that is in the
same class of property and placed in service in the same taxable year,
and no additional first year depreciation deduction is allowable for the
class of property.

\(2\) [Definition of class of property]{.underline}. For purposes of
this paragraph (e), the term class of property means\--

\(i\) Except for the property described in paragraphs (e)(2)(ii), (iv),
and (v) of this section, each class of property described in section
168(e) (for example, 5-year property);

\(ii\) Water utility property as defined in section 168(e)(5) and
depreciated under section 168;

\(iii\) Computer software as defined in, and depreciated under, section
167(f)(1) and the regulations thereunder;

\(iv\) Nonresidential real property as defined in paragraph (b)(3) of
this section and as described in paragraph (c)(2)(B) of this section; or

\(v\) Residential rental property as defined in paragraph (b)(3) of this
section and as described in paragraph (c)(2)(B) of this section

\(3\) [Time and manner for making election]{.underline}\--(i) [Time for
making election]{.underline}. Except as provided in paragraph (e)(4) of
this section, the election specified in paragraph (e)(1) of this section
must be made by the due date (including extensions) of the federal tax
return for the taxable year in which the qualified New York Liberty Zone
property is placed in service by the taxpayer

\(ii\) [Manner of making election]{.underline}. Except as provided in
paragraph (e)(4) of this section, the election specified in paragraph
(e)(1) of this section must be made in the manner prescribed on Form
4562, "Depreciation and Amortization," and its instructions. The
election is made separately by each person owning qualified New York
Liberty Zone property (for example, for each member of a consolidated
group by the common parent of the group, by the partnership, or by the S
corporation). If Form 4562 is revised or renumbered, any reference in
this section to that form shall be treated as a reference to the revised
or renumbered form.

\(4\) [Special rules for 2000 or 2001 returns]{.underline}. For the
election specified in paragraph (e)(1) of this section for qualified New
York Liberty Zone property placed in service by the taxpayer during the
taxable year that included September 11, 2001, the taxpayer should refer
to the guidance provided by the Internal Revenue Service for the time
and manner of making this election on the 2000 or 2001 federal tax
return for the taxable year that included September 11, 2001 (for
further guidance, see sections 3.03(3) and 4 of Rev. Proc. 2002-33
(2002-1 C.B. 963), Rev. Proc. 2003-50 (2003-29 I.R.B. 119), and
§601.601(d)(2)(ii)([b]{.underline}) of this chapter).

\(5\) [Failure to make election]{.underline}. If a taxpayer does not
make the election specified in paragraph (e)(1) of this section within
the time and in the manner prescribed in paragraph (e)(3) or (e)(4) of
this section, the amount of depreciation allowable for that property
under section 167(f)(1) or under section 168, as applicable, must be
determined for the placed-in-service year and for all subsequent taxable
years by taking into account the additional first year depreciation
deduction. Thus, the election specified in paragraph (e)(1) of this
section shall not be made by the taxpayer in any other manner (for
example, the election cannot be made through a request under section
446(e) to change the taxpayer=s method of accounting).

\(f\) [Special rules]{.underline}\--(1) [Property placed in service and
disposed of in the same taxable year]{.underline}. Rules similar to
those provided in §1.168(k)-1T(f)(1) apply for purposes of this
paragraph (f)(1).

\(2\) [Redetermination of basis]{.underline}. If the unadjusted
depreciable basis (as defined in §1.168(k)-1T(a)(2)(iii)) of qualified
New York Liberty Zone property is redetermined (for example, due to
contingent purchase price or discharge of indebtedness) on or before
December 31, 2006 (or on or before December 31, 2009, for nonresidential
real property and residential rental property described in paragraph
(c)(2)(i)(B) of this section), the additional first year depreciation
deduction allowable for the qualified New York Liberty Zone property is
redetermined in accordance with the rules provided in
§1.168(k)-1T(f)(2).

\(3\) [Section 1245 and 1250 depreciation recapture]{.underline}. The
rules provided in §1.168(k)-1T(f)(3) apply for purposes of this
paragraph (f)(3).

\(4\) [Coordination with section 169]{.underline}. Rules similar to
those provided in §1.168(k)-1T(f)(4) apply for purposes of this
paragraph (f)(4).

\(5\) [Like-kind exchanges and involuntary conversions]{.underline}.
This paragraph (f)(5) applies to acquired MACRS property (as defined in
§1.168(k)-1T(f)(5)(ii)(A)) or acquired computer software (as defined in
§1.168(k)-1T(f)(5)(ii)(C)) that is eligible for the additional first
year depreciation deduction under section 1400L(b) at the time of
replacement provided the time of replacement is after September 10,
2001, and on or before December 31, 2006, or in the case of acquired
MACRS property or acquired computer software that is qualified New York
Liberty Zone property described in paragraph (c)(2)(i)(B) of this
section, the time of replacement is after September 10, 2001, and on or
before December 31, 2009. The rules and definitions similar to those
provided in §1.168(k)-1T(f)(5) apply for purposes of this paragraph
(f)(5).

\(6\) [Change in use]{.underline}. Rules similar to those provided in
§1.168(k)-1T(f)(6) apply for purposes of this paragraph (f)(6).

\(7\) [Earnings and profits]{.underline}. The rule provided in
§1.168(k)-1T(f)(7) applies for

purposes of this paragraph (f)(7).

\(8\) [Section 754 election]{.underline}. Rules similar to those
provided in § 1.168(k)-1T(f)(9)

apply for purposes of this paragraph (f)(8).

\(g\) [Effective date]{.underline}\--(1) [In general]{.underline}.
Except as provided in paragraphs (g)(2) and (3) of this section, this
section applies to qualified New York Liberty Zone property acquired by
a taxpayer after September 10, 2001. This section expires on September
7, 2006.

\(2\) [Technical termination of a partnership or section 168(i)(7)
transactions]{.underline}. If qualified New York Liberty Zone property
is transferred in a technical termination of a partnership under section
708(b)(1)(B) or in a transaction described in section 168(i)(7) for a
taxable year ending on or before September 8, 2003**,** and the
additional first year depreciation deduction allowable for the property
was not determined in accordance with paragraph (f)(1) of this section,
the Internal Revenue Service will allow any reasonable method of
determining the additional first year depreciation deduction allowable
for the property in the year of the transaction that is consistently
applied to the property by all parties to the transaction.

\(3\) [Like-kind exchanges and involuntary conversions]{.underline}. If
a taxpayer did not claim on a federal tax return for a taxable year
ending on or before September 8, 2003, the additional first year
depreciation deduction for the remaining carryover basis of qualified
New York Liberty Zone property acquired in a transaction described in
section 1031(a), (b), or (c), or in a transaction to which section 1033
applies and the taxpayer did not make an election not to deduct the
additional first year depreciation deduction for the class of property
applicable to the remaining carryover basis, the Internal Revenue
Service will treat the taxpayer's method of not claiming the additional
first year depreciation deduction for the remaining carryover basis as a
permissible method of accounting and will treat the amount of the
additional first year depreciation deduction allowable for the remaining
carryover basis as being equal to zero, provided the taxpayer does not
claim the additional first year depreciation deduction for the remaining
carryover basis in accordance with paragraph (g)(4)(ii) of this section.

\(4\) [Change in method of accounting]{.underline} \--(i) [Special rules
for 2000 or 2001 returns]{.underline}. If a taxpayer did not claim on
the federal tax return for the taxable year that included September 11,
2001, any additional first year depreciation deduction for a class of
property that is qualified New York Liberty Zone property and did not
make an election not to deduct the additional first year depreciation
deduction for that class of property, the taxpayer should refer to the
guidance provided by the Internal Revenue Service for the time and
manner of claiming the additional first year depreciation deduction for
the class of property (for further guidance, see section 4 of Rev. Proc.
2002-33 (2002-1 C.B. 963), Rev. Proc. 2003-50 (2003-29 I.R.B. 119), and
§601.601(d)(2)(ii)([b]{.underline}) of this chapter).

\(ii\) [Like-kind exchanges and involuntary conversions]{.underline}. If
a taxpayer did not claim on a federal tax return for any taxable year
ending on or before September 8, 2003**,** the additional first year
depreciation deduction allowable for the remaining carryover basis of
qualified New York Liberty Zone property acquired in a transaction
described in section 1031(a), (b), or (c), or in a transaction to which
section 1033 applies and the taxpayer did not make an election not to
deduct the additional first year depreciation deduction for the class of
property applicable to the remaining carryover basis, the taxpayer may
claim the additional first year depreciation deduction allowable for the
remaining carryover basis in accordance with paragraph (f)(5) of this
section either\--

\(A\) By filing an amended return (or a qualified amended return, if
applicable (for further guidance, see Rev. Proc. 94-69 (1994-2 C.B. 804)
and §601.601(d)(2)(ii)([b]{.underline}) of this chapter)) on or before
December 31, 2003, for the year of replacement and any affected
subsequent taxable year; or,

\(B\) By following the applicable administrative procedures issued under
§1.446-1(e)(3)(ii) for obtaining the Commissioner's automatic consent to
a change in method of

accounting (for further guidance, see Rev. Proc. 2002-9 (2002-1 C.B.
327) and §601.601(d)(2)(ii)([b]{.underline}) of this chapter).

Deputy Commissioner for Services and Enforcement.

Approved:

Assistant Secretary of the Treasury (Tax Policy).