The concept of “placed in service” for purposes of beginning to deduct depreciation is often a tricky one to deal with in real life, and the date of placing an item in service may not be as simple to discern as some might believe. Certainly, in the case of Stine, LLC v. United States, 115 AFTR 2d ¶ 2015-381, DC LA, the IRS’s view of a “bright line” test based on a when a building was open for business was rejected by the Court. And, in 2017, the IRS returned the favor by rejecting the Court’s holding, announcing in Action on Decision 2017-02 that the agency does not acquiesce in the decision and will continue to take the position in a similar case that a retail building had not been placed in service when it reaches the state it did in this case.
The case involved a building which had been substantially completed and had a certificate of occupancy prior to December 31, 2008. That date was important because the property was located in the “Go Zone” where qualified real property placed in service prior to that date would qualify for 50% bonus depreciation.
The IRS argued that the buildings had to be open for business in order to be placed in service. In fact, at December 31, 2008 the buildings were not open for business and the certificates of occupancy did not allow customers to enter the building.
However, the taxpayer argued (successfully in the end) that the real question was whether the buildings were substantially complete and available for their intended use by December 31, 2008. That intended use was to store and house equipment, racks, shelving and merchandise. The taxpayer presented testimony of the building’s architect that the buildings were substantially complete as of that date and that limited occupancy was granted.
The IRS argued that to allow the taxpayer a deduction at this point would violate the principal of matching expenses with revenue, since clearly no revenue could be derived from the property until it was open for business. The Court found that no case law existed suggesting that such a bright line existed and, in fact, the very allowance of a 50% write off in the first year would, by itself, violate any such principal.
The Court cited Reg. §1.167(a)-10(b) which provides, in part:
In the case of a building which is intended to house machinery and equipment and which is constructed, reconstructed, or erected by or for the taxpayer and for the taxpayer's use, the building will ordinarily be placed in service on the date such construction, reconstruction or erection is substantially complete· and the building is in a condition or state of readiness and availability. Thus, for example, in the case of a factory building, such readiness and availability shall be determined without regard to whether the machinery or equipment which the building houses, or is intended to house, has been placed in service.
The Court distinguished the cases the IRS attempted to rely upon from the current case, noting that the case in question generally involved equipment (not buildings).
The taxpayer, conversely, pointed out the loss by the taxpayer in the case of Williams v. Commissioner, TC Memo 1987-308. In that case a taxpayer attempted to claim a placed in service date for a building that required substantial refurbishing before it could be fully utilized in the business by pointing out the building was used to some extent in the business prior to when the refurbishing was complete—that is, it was “open” at that point. In that case the Tax Court rejected that view of “placed in service” and instead held the building was not in service until the refurbishing was complete.
The Court agreed with the taxpayer’s view. The Court concluded:
… the building is placed in service when it is substantially complete meaning in a condition of readiness and availability to perform the function for which it was built-in this instance to house and secure racks, shelving and merchandise. The court finds that the Walker and Broussard buildings were placed in service prior to December 31, 2008 fully qualifying the taxpayer to take advantage of the "Go Zone" bonus depreciation allowance.
Two year later, on April 10, 2017, the IRS decided to formally announce that they will not follow this case and will continue to litigate the issue.
The IRS argues first that the Court erred in deciding the taxpayer’s intended use for the building was to “house and secure racks, shelving and merchandise,” arguing the taxpayer intended to use the buildings as retail stores, not just to house items.
The IRS also argued that the facts did not comply with the requirement in the regulations that property be “in a condition or state of readiness and availability for its specifically assigned function” which the IRS argues is being “ready and available for regular operation and income producing use.”
The IRS goes on to note:
The meaning of regular operational use for income production has been developed by the Tax Court and the Service in the context of electric power plants. Oglethorpe Power Corp. v. Commissioner, T.C. Memo. 1990-505 (facility placed in service upon sustained power generation near rated capacity); Consumers Power Co. v. Commissioner, 89 T.C. 710 (1987) (same). In Sealy Power, supra, the Fifth Circuit Court of Appeals held that an electric power plant that operated on a regular basis, but did not produce the projected quantity of electricity, may be considered placed in service. In recommending nonacquiescence to Sealy, the Service stated that at a minimum, the property must be in a state of readiness sufficient to produce electricity on a sustained and reliable basis in commercial quantities. Sealy Power, AOD 1995-10 (Aug. 7, 1995). In Rev. Rul. 76-428, 1976-2 C.B. 47, and Rev. Rul. 76-256, 1976-2 C.B. 46, the Service outlines five factors to determine whether electric power facilities are ready and available for regular operation: (1) approval of all required licenses and permits; (2) passage of control of the facility to the taxpayer; (3) completion of critical tests; (4) commencement of daily or regular operations; and (5) with respect to electric power plants, synchronization of the plant facility into a power grid.
The IRS ends the AOD with a summary of its current position:
The Commissioner will continue to litigate this issue, taking the position that (1) under § 1.46-3(d)(1)(ii), a retail store is placed in service for depreciation purposes when the building is ready and available to operate as a retail store, the function for which it was built, and (2) the store’s ability to begin operations is determined by considering the applicable factors set forth in Rev. Rul. 76-256 and Rev. Rul. 76-428.