Here’s a typical fact pattern in a tax equity partnership in which the investment tax credit recapture period or the production tax credit availability period is over: A and B are unrelated parties that formed an LLC that is classified as a partnership for tax purposes (“AB LLC”). A is a tax equity investor and B is a managing member of AB LLC. AB LLC owns only one asset—a solar energy project that was originally placed in service by the partnership five years ago. B has a basis in its AB LLC interest of $5. B acquires A’s interest in AB LLC for $15, resulting in B being the only member in AB LLC. Does B qualify to take a bonus depreciation deduction under section 168(k) with respect to the solar project when B acquires A’s interest in AB LLC? If so, how much?
I. B’s Basis in the Project
When B acquires A’s AB LLC interest, the LLC becomes a disregarded entity and the partnership is treated as if it was terminated. For purposes of determining the tax treatment of B, AB LLC is deemed to make a liquidating distribution of the solar project to A and B. Following this deemed distribution, B is treated as acquiring from A's portion of the solar project deemed to have been distributed to A in liquidation of A’s LLC interest. Thus, B’s basis in A’s portion of the solar project is $15, the purchase price for A’s LLC interest as determined under section 1012. B’s basis in its own portion of the solar project is $5, B’s carryover basis in the asset as determined under section 732(b), which governs transactions where property is distributed to a partner by a partnership in the liquidation of partner’s interest. Therefore, B’s basis in its interest in the entire solar project is $20 (i.e., $15, as determined under section 1012, plus $5, as determined under section 732(b)).
II. Bonus Depreciation Under Section 168
Used property qualifies for a bonus depreciation if (1) it has not been used by the taxpayer or a “predecessor” within five calendar years immediately prior to the current calendar year in which the property is placed in service by the taxpayer (“No Prior Use Requirement”); (2) it is either acquired by purchase within the meaning of section 1.179-4(c)(2) or meets the requirements of section 179(d)(2)(A), (B), & (C), and section 1.179-4(c)(1)(ii), (iii) & (iv); and (3) the acquisition of such property meets the requirements of section 179(d)(3) and section 1.179-4(d) (cost basis of the property is determined by reference to the basis of other property held by the taxpayer (e.g., like-kind exchange)).
In the preamble to the proposed regulations Treasury observed that when a partner in a partnership acquires another partner’s interest in the partnership, the transferee partner’s existing interest in the underlying partnership property is distinct from the interest being acquired. Hence, to determine whether B satisfies the used property bonus depreciation qualification requirements stated above, B’s interest in the solar project should be evaluated in two steps. First, B’s own interest in the project should be considered. Second, interest that B acquires from A should be separately evaluated.
The regulations provide that used property that is distributed by a partnership to a partner and basis of which is determined under section 732 is not eligible for a bonus depreciation. Thus, assuming used property requirements discussed above are satisfied, B might qualify for a bonus depreciation deduction with respect to portion of the solar project that is attributed to A (i.e., $15 basis), but not with respect to portion attributed to B (i.e., $5 basis) since B’s basis in B’s share of the solar project is determined under section 732(b).
1. The No Previous Use Requirement
Neither B nor A has ever used A’s portion of the solar project directly. Instead, the project was placed in service and has always been used by AB LLC. Under the proposed regulations issued in 2019, a partner was treated as having a depreciable interest in partnership property (i.e., deemed to use the property) solely by virtue of being a partner in the partnership (“Lookthrough Rule”). However, the final regulations issued in November 2020 removed the Lookthrough Rule and a partner in the partnership is no longer treated as having proportionate interest in partnership property for purposes of the bonus depreciation rules. In the preamble to the final regulations, the IRS reasoned the complexity of applying the Lookthrough Rule would place a significant administrative burden on taxpayers and the IRS alike thus should be removed. Since B has never directly used the solar project and is not deemed to have used the property by virtue of being a member in AB LLC, the solar project satisfies the No Prior Use Requirement.
2. The property is acquired by purchase or meets certain other requirements
Under section 1.179-4(c)(2), property is not acquired by purchase to the extent it is acquired from a person whose relationship to the person acquiring it would result in the disallowance of losses under section 267 or section 707(b). Section 267 and 707(b) discuss disallowance of losses from the sale or exchange of property between related parties and between a partner and a controlled partnership. Under the facts presented, B and A are not related parties. Thus, B acquires A’s AB LLC interest, and as the result portion of the solar project attributed to A, by purchase within the meaning of section 1.179-4(c)(2). The second prong of the used property bonus depreciation eligibility requirement is satisfied.
3. The acquisition of property meets section 179(d)(3) and section 1.179-4(d) requirements
Under section 179(d)(3) and section 1.179-4(d), the cost of property may not include so much of the basis of the property as is determined by reference to the basis of other property held at any time by the person acquiring such property. Generally, these provisions apply to like-kind exchanges of property. Here, under section 1012, B’s basis in portion of the solar project attributed to A is determined based on the price B paid to A for A’s interest in AB LLC, as opposed to A’s basis in the LLC interest. Thus, the third prong of the used property bonus depreciation eligibility requirement is satisfied.
Since all used property bonus depreciation eligibility requirements listed in section 1.168(k)-2(b)(3) are satisfied with respect to portion of the solar project that B acquires from A, B is able to claim a bonus depreciation deduction for $15 of its basis in the solar project.
 All references in this memorandum to a “section” or “§” without identifying the source are to a section of the Internal Revenue Code of 1986 and regulations thereunder, as amended through today’s date.