For Depreciation Purposes, What Does Placed in Service Mean?

Overview

Any depreciable business asset is only depreciable if it has been placed in service during the tax year.  “Placed in service” means that the asset is in a state of readiness for use in the taxpayer’s trade or business.  See, e.g., Brown v. Comr., T.C. Sum. Op. 2009-71.  In the year that an asset is place in service, all or part of the income tax basis can be deducted currently.  A key point is that it is not actually necessary that the asset be used in the taxpayer’s trade or business for the taxpayer to begin claiming depreciation attributable to that asset. 

The Code and regulations seem abundantly clear on what “placed in service” means.  A court decision involving a retail building that was decided in early 2015 bore that out.  But, IRS has now muddied the water by disagreeing with that court’s decision which, in turn, means that they are disagreeing with their own regulation on the issue and even their own audit technique guide on the matter.

Today’s post takes a look at what “placed in service” means and the confusing IRS position. 

Code and Regulations

As noted above, property that is “placed in service” means that it is placed in a state of readiness or availability for use in the taxpayer’s trade or business, regardless of the time of year that the asset is placed in service.  Treas. Reg. §1.167(a)-10(b).  That means that the asset must be ready for the taxpayer to use by the taxpayer by the end of the tax year if the taxpayer so desires.  It doesn’t mean that the taxpayer must have begun using the asset in the taxpayer’s trade or business by the end of the tax year.  But, an item of property is not deemed to be placed in service if it is simply manufactured and is sitting at the dealership, or if an order has been placed but the property has not yet been built.  So, simply signing a purchase contract or taking delivery of a depreciable materials (such as for the construction of a pole barn, etc.) to be used in the taxpayer’s business does not mean that those assets are depreciable – they aren’t yet ready for use in the taxpayer’s business.  The asset must be ready for use in the taxpayer’s business whether or not they have actually been used by the taxpayer in the business by the end of the tax year.  For a building in which the taxpayer’s retail business is conducted, for example, the store doesn’t have to be open for business in order for the building by the end of the tax year for the building to be deemed to be placed in service for depreciation purposes for that tax year.  Treas. Reg. §1.167(a)-11(e)(1)(i).  The building is considered to be placed in service on the date that its construction is considered to be substantially complete or in the state or readiness and availability regardless of whether depreciable items in the building meet the placed in service test.  Id.

The Stine Case

In Stine, LLC v. United States, No. 2:13-03224, 2015 U.S. Dist. LEXIS 9850 (W.D. La. Jan. 27, 2015), non-acq., 2017-02 (Apr. 10, 2017), the taxpayer operated a retail business that sold home building materials and supplies. The taxpayer built two new retail stores. As of December 31, 2008, the buildings were substantially complete and partially occupied and the taxpayer had obtained certificates of completion and occupancy and customers could enter the stores. However, the stores were not open for business as of the end of 2008. The taxpayer claimed the 50 percent GoZone depreciation allowance for 2008 on the two buildings which created a tax loss for 2008 and allowed the taxpayer to carry back the losses to the 2003-2005 tax years and receive a refund. The IRS disallowed the depreciation deduction on the basis that the taxpayer had not placed the buildings in service and assessed a deficiency of over $2.1 million for tax years 2003-2008. The taxpayer paid the deficiency and sued for a refund. The IRS argued that allowing the depreciation would offend the "matching principle" because the taxpayer's revenue from the buildings would not match the depreciation deductions for a particular tax year. The court held that this argument was "totally without merit."  

On the placed in service issue, the IRS maintained that the two buildings were not “open for business” as of the end of the tax year so no depreciation could be claimed for that year.  The court disagreed, noting the government’s own regulation that defied that argument.  The court noted that Treas. Reg. §1.167(a)-11(e)(1) says that placed in service means that the asset is in a condition of readiness and availability for its assigned function. With respect to a building, the court noted that this meant that the building must be in a state of readiness and availability without regard to whether equipment or machinery housed in the building has been placed in service. The court held that there was no requirement that the taxpayer's business must have begun by year-end. Cases that the IRS cited involving equipment (in one case an airplane) being placed in service were not applicable, the court determined. The court also noted that the IRS's own Audit Technique Guide for Rehabilitation Tax Credits stated that "[A] 'Certificate of Occupancy' is one means of verifying the 'Placed in Service' date for the entire building (or part thereof)". The court noted that the IRS had failed to cite even a single authority for the proposition that "placed in service" means "open for business," and that during oral arguments IRS had admitted that no authority existed.  Thus, the court granted summary judgment for the taxpayer and also specified that the taxpayer could pursue attorney fees against the government if desired.

The IRS reaction.  The court’s decision in Stine was based precisely on the regulation.  It’s common sense, also.  For retail businesses that are constructing stores, once the product is received to be placed into the display shelves at the constructed building, the building will be considered to have been placed in service.  That’s what the regulation seems pretty clear about.  The court sure believed so.  

The IRS did not file an appeal with the U.S. Court of Appeals for the Fifth Circuit.  That’s not surprising, considering how badly the IRS lost the case.  Recently, however, the IRS issued a non-acquiescence to the court’s decision.  A.O.D. 2017-02.  That means that the IRS disagrees with the court’s decision and will continue to audit the issue outside of the Western District of Louisiana.  Unfortunately, the IRS didn’t give any reason(s) why it disagreed with its own regulation and audit technique guide on the matter.  That’s understandable – they have none.

Conclusion

An asset is placed in service for depreciation purposes when it is ready and available for use in the taxpayer’s trade or business.  The Stine case makes that clear. It’s an issue that comes up in agriculture also. Just think back to the end of the year promotional ads that have appeared on TV and in farm magazines in recent years stating that a contract could be signed or delivery be taken before year end for a business asset to be depreciable.  That’s not correct.  While the asset need not be “used” by the taxpayer to be placed in service, it still has to be ready and available for use.  Merely signing a contract or taking delivery of parts and materials that have to be assembled is not enough.