Beginning Depreciation-Courts Weigh in on When Property is “Placed in Service”

 

For owners of real property, the depreciation deduction provides an opportunity to deduct costs incurred for capital improvements. Under the relevant provisions of the Internal Revenue Code, a property owner is entitled to a deduction for the tax year equal to the unadjusted basis of the property times the applicable percentage outlined in the Treasury Regulations for the type of property placed in service. One of the biggest questions that arises is when the taxpayer is eligible to begin claiming depreciation deductions.
Pursuant to Reg. Sec. 1.167(a)-10, the depreciation period for an asset begins when the asset is “placed in service”. As explained in Reg. Sec. 1.167(a)-11(e)(1)(i), property is first placed in service when it is placed in a condition or state of readiness and availability for a specifically assigned function. The issue of when buildings are placed in service was recently addressed by the courts in Stine, LLC v. USA.
In Stine, the court was faced with a dispute over when certain units of property, specifically buildings used for a retail operation, were placed in service for purposes of claiming depreciation deductions. The taxpayer argued that when the buildings were substantially complete, the buildings were ready and available for their intended use and, as a result, depreciation should begin. The IRS disagreed and argued that the buildings needed to be open for business before a valid depreciation deduction could be claimed.
At the time depreciation was claimed by Stine, LLC, the stores in question had been issued certificates of occupancy which allowed for the delivery of equipment, shelving, racks and merchandise. In addition, the appropriate personnel were permitted in the buildings to install the equipment, shelving and racks and stock the merchandise. It was not disputed that the stores were not open for business and the certificates of occupancy did not allow the public to enter the buildings.
In ruling for Stine and determining that the depreciation deductions in question were valid, the court looked to the language in the Internal Revenue Code and the Regulations thereunder. They also looked at case law. After considering all of these sources, the court decided that “whether a building is open for business is of no moment; rather the building is placed in service when is it substantially complete, meaning in a condition of readiness and availability to perform the function for which it was built.” The court further reasoned that if lawmakers desired for the building to be open to the public, that language would have been added to the relevant regulations.
The Stine case can be used by taxpayers as a guide to determine when to begin claiming depreciation on their buildings. After this ruling, a taxpayer does not need to wait until the building is actually open to the public. They can begin to depreciate the building when it is ready and available to perform the function for which it was built, which in many cases will allow for an earlier placed-in-service date.
It is important to note that in April 2017, the IRS issued notice to taxpayers that they do not acquiesce to the holding in Stine. As a result, it is possible that the IRS may challenge taxpayers who use the holding in Stine to place retail buildings in service prior to the date that they are officially open to the public.
For questions on how this case and the notice on non-acquiescence may impact your business, please reach out to Rebecca Machinga, Real Estate Team Leader at rmachinga@withum.com.
Sara Palovick, CPA, Withum Real Estate Services team member. 

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