Does NC vs federal depreciation affect carryover losses or basis calculations for partnerships?

The difference between North Carolina’s depreciation rules (specifically, its decoupling from federal bonus depreciation and Section 179 expensing) and federal depreciation methods can have significant effects on both the calculation of carryover losses and basis calculations for partnerships operating in North Carolina.

1. North Carolina’s Decoupling from Federal Depreciation

North Carolina does not conform to federal bonus depreciation under IRC § 168(k) or the federal Section 179 expensing limits. Instead, North Carolina requires taxpayers to add back a portion of the federal bonus depreciation or excess Section 179 expense to income in the year taken, and then allows a deduction for that amount ratably over five subsequent years. This is commonly referred to as a “decoupling adjustment”.

• For bonus depreciation, 85% of the federal deduction is added back in the year taken, and 20% of the add-back is deducted in each of the next five years.
• For Section 179, the add-back applies to the amount by which the federal deduction exceeds the North Carolina limits ($25,000 for the dollar limitation and $200,000 for the investment limitation for tax years beginning on or after 2013).

2. Effect on Carryover Losses

Federal vs. North Carolina Losses

• Federal NOLs: At the federal level, net operating losses (NOLs) are calculated using federal taxable income, which includes the full benefit of federal bonus depreciation and Section 179 expensing.
• North Carolina Losses: For North Carolina purposes, the add-back of bonus depreciation and excess Section 179 means that state taxable income is higher in the year of the federal deduction, and lower in the subsequent five years as the add-back is deducted. This timing difference can result in a different amount of state net loss (called a “State net loss” or “net economic loss” for years before 2015) compared to the federal NOL.

Impact:- The decoupling adjustment can reduce or eliminate a North Carolina net loss in the year federal bonus depreciation is claimed, even if a federal NOL exists.- Conversely, in the five subsequent years, the North Carolina deduction for the add-back may increase the state net loss or reduce state taxable income, even if there is no federal NOL in those years.- This means that the amount and timing of loss carryforwards for North Carolina purposes may differ from federal loss carryforwards, and the two must be tracked separately.

3. Effect on Basis Calculations for Partnerships

Inside and Outside Basis

• Federal Basis: For federal tax purposes, a partner’s outside basis in a partnership is increased by the partner’s share of income (including depreciation deductions) and decreased by losses and distributions. The partnership’s inside basis in its assets is also affected by depreciation taken at the partnership level.
• North Carolina Basis: North Carolina law generally provides that the decoupling adjustments do not create a difference in basis for state and federal purposes, except in certain transfer situations (such as when a bonus asset basis adjustment is required upon a transfer of property with a carryover basis).

Key Points:- The decoupling adjustment is a modification to income, not to basis. Thus, for most purposes, the partnership’s inside basis in its assets and the partners’ outside basis in their partnership interests remain the same for both federal and North Carolina purposes, despite the different timing of depreciation deductions.- However, if there is a transfer of an asset with a carryover basis (such as in a Section 754 election or a Section 704(c) remedial allocation), North Carolina may require a basis adjustment to reflect any remaining bonus depreciation deductions that have not yet been claimed for state purposes. In such cases, the transferee may be required to add any remaining deductions to the basis of the asset and depreciate it over the remaining life of the asset.

4. Practical Implications for Partnerships

• Tax Reporting: Partnerships must track North Carolina decoupling adjustments separately from federal depreciation, and partners must be informed of their share of these adjustments for state tax reporting.
• Loss Utilization: The timing and amount of North Carolina net losses available for carryforward may differ from federal NOLs, affecting the ability to offset future income at the state level.
• Basis Parity: Except in specific transfer situations, basis calculations for both inside and outside basis are not affected by the decoupling adjustment, but the timing of income and loss recognition for state purposes is affected.

5. Summary Table Example

(Assumes $100,000 bonus depreciation, 85% add-back, 20% deduction over 5 years; simplified for illustration.)

6. Conclusion

The difference between North Carolina’s and federal depreciation methods does not generally affect the basis of partnership property or partner interests, except in certain transfer situations. However, it does affect the calculation and timing of state net losses, which may differ from federal NOLs and must be tracked separately for North Carolina tax purposes. Partnerships and their partners must be diligent in tracking these differences to ensure proper reporting and utilization of losses at the state level.

If you need more detail on a specific scenario (such as a Section 754 election, Section 704(c) allocations, or a particular type of asset transfer), please provide additional facts.