A taxpayer begins depreciating property when it is Placed in Service for use in the taxpayer’s trade or business or for the production of income.
The taxpayer stops depreciating property either when the taxpayer has Fully Recovered the Property’s Cost or other basis or when the taxpayer retires it from service, whichever happens first (Regulation Section 1.167(a)-10(b); Hutchinson v. Commissioner, 116 Tax Court 172 (2001)).
Determining when property is placed into service depends on who placed it in serve, as the term “First Placed in Service” refers to the time the property is first placed in service by the taxpayer, not to the first time the property is placed in service. Property is considered placed in service when it is ready and available for a specific use, whether in a business activity, an income-producing activity, a tax-exempt activity, or a personal activity (Regulation Section 1.167(a)-11(e)(1)(i)). Even if the taxpayer is not using the property, it is still considered placed in service when it is ready and available for its specific use (Regulation Section 1.167(a)-11(e)(1); Northern States Power Company v. United States, 151 Federal Supplement 3rd 876 (8th Circuit 1998)).
Example:
Joey BagofDonuts bought equipment for his business. The equipment was delivered last year. However, it was not installed and operational until this year. It is considered placed in service this year. If the machine had been ready and available for use when it was delivered, it would be considered placed in service last year even if it was not actually used until this year.
Example:
On April 3, Joey BagofDonuts bought a house to use as residential rental property. He made several repairs and had it ready for rent on July 1. At that time, he began to Advertise the Property for Rent in the local newspaper. The house is considered placed in service in July when it was ready and available for rent. Joey can begin to depreciate it in July.
Example:
Joey BagofDonuts is a building contractor who specializes in constructing office buildings. He bought a truck last year that had to be modified to lift materials to second-story levels. The installation of the lifting equipment was completed and Joey accepted delivery of the modified truck on January 10 of this year. The truck was placed in service on January 10, the date it was ready and available to perform the function for which it was bought.
In Consumers Power Company v. Commissioner, 89 Tax Court 710 (1987), the Tax Court held that the fact that a taxpayer uses an asset in his business sometime during the course of a year doesn’t necessarily mean that he placed it in service that year. In Brown v. Commissioner, Tax Court Memo. 2013-275, the Tax Court cited its holding in Consumers Power in concluding that, because an insurance salesman’s jet did not have a conference table and a screen large enough for power point presentations, something the taxpayer said was required for his business, the jet wasn’t fully functional for the very specific needs of the taxpayer’s business until those features were added in a subsequent year.
Depreciation is available even though the property used in the taxpayer’s business or for the production of income is temporarily idle (that is, not in use) (Regulation Section 1.263A-1(e)(3)(iii)(E)).
Observation: This might happen, for example, if the Taxpayer Stops using a Machine because there is a temporary lack of a market for a product made with that machine.
Courts have recognized that taxpayers may claim depreciation deductions under the so-called “Idle Asset” rule in situations where the asset involved, while not in actual use during the year in issue, nevertheless was devoted to the business of the taxpayer and ready for use should the occasion arise (Piggly Wiggly Southern, Inc. v. Commissioner, 84 Tax Court 739 (1985); Clemente, Inc. v. Commissioner, Tax Court Memo. 1985-367).
In P. Dougherty Company v. Commissioner, 159 Company 269 (4th Circuit 1946), affirming 5 Tax Court 791 (1945), the court held that, for purposes of determining whether depreciation was allowable for years when barges laid idle for protracted periods during a 20-year period, it was sufficient that they were kept in usable condition and were ready for use should the occasion arise.
In Kittredge v. Commissioner, 88 Federal Supplement 2nd 632 (2d Circuit 1937), the court said that the phrase “Used in the Trade or Business” should be read as equivalent to “devoted to the trade or business”; that is to say, that property once used in the business remains in such use until it is shown to have been withdrawn from business purposes.
In Piggly Wiggly Southern, Inc. v. Commissioner, 84 Tax Court 739 (1985), Affirmed, 803 Federal Supplement 2nd 1572 (11th Circuit 1986), the Tax Court set forth the requirements for applying the Idle Asset Rule. The court identified two necessary factors:
(1) the taxpayers already were engaged in the business for which they purchased the equipment; and
(2) the taxpayers did all that was in their power to place the equipment into service.
In Stine v. United States, 2015 Protection Tax Credit 477 (Western District Louisiana), a taxpayer, who operated retail stores that sold building materials and supplies to consumers and contractors, began construction of two new buildings to function as retail stores. At the end of the year, both of the buildings had received only a 30-day certificate of occupancy issued by the state fire marshal that allowed them to receive equipment, shelving, racks and merchandise and allowed employees to install or stock those items. At the end of the year, the buildings were not ready to operate as retail stores and customers were not permitted to enter the buildings under the certificates of occupancy then in place. A district court held that the buildings were placed in service at the end of the year because they were “substantially complete meaning in a condition of readiness and availability to perform the function for which [they were] built-in this instance to house and secure racks, shelving and merchandise.”
In Actions on Decisions 2017-2, the IRS issued a Nonacquiescence to the Stine decision, saying that the court erred in holding that the taxpayer’s intended use for the buildings was to house and secure racks, shelving and merchandise. Citing decisions in Sealy Power, Ltd. v. Commissioner, 46 Federal Supplement 3rd 382 (5th Circuit 1995) and Brown v. Commissioner, Tax Court Memo. 2013-275, the IRS said the threshold determination in a placed in service analysis is to identify the specifically assigned function of the property in the context of the taxpayer’s trade or business and, in the instant case, the taxpayer intended to use the buildings as retail stores, not to house machinery and equipment. Citing Regulation Section 1.46-3(d)(1)(ii), the IRS said the court also erred by failing to observe the regulatory requirement that property is placed in service when it is in a condition or state of readiness and availability for its specifically assigned function; that is, when it is ready and available for regular operation and income-producing use.
In Scheidt v. Commissioner, Tax Court Memo. 1992-9, the Tax Court held that a horse, an Arabian stallion, was considered Placed in Service where it was in fact being bred and remained in a state of readiness and available for increased breeding activity had advertising efforts generated the hoped for demand.
If the taxpayer places property in service in a personal activity, no depreciation can be claimed. However, if the taxpayer changes the property’s use to a business or income-producing activity, then the taxpayer can begin to depreciate it at the time of the change. The property is considered Placed in Service on the date of the change (Regulation Section 1.168(i)-4(b)(1)).
Example:
Lizzy BagofDonuts bought a home and used it as her personal home several years before she converted it to rental property. Sylvia can begin to claim depreciation in the year she converted it to rental property because its use changed to an income-producing use at that time. For depreciation purposes, the property is considered placed in service on the date of the change
A taxpayer Stops Depreciating Property when the taxpayer has Fully Recovered its Cost or other basis. A taxpayer recovers its basis when the taxpayer’s Code Sec. 179 deductions and allowed or allowable depreciation deductions equal the taxpayer’s cost or investment in the property.
A taxpayer also Must Stop Depreciating Property When he or she Retires the Property from Service. Property is considered withdrawn from use in a trade or business or from use in the production of income upon the occurrence of any of the following events:
(1) The property is Sold or Exchanged.
(2) The property is Converted to Personal Use.
(3) The Property is Abandoned.
(4) The Property is Destroyed.
(5) The property is Transferred to a Supplies or Scrap account (Regulation Sections 1.167(a)-8(a), 1.167(a)-10(b)).
Please contact the office of Don Fitch Accountancy at (760)567-3110 or Email Don.Fitch@CPA.com if you have any questions or would like additional information.
DON FITCH, CPA
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Palm Desert, CA 92260
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(Updated 06192021-1 94-110)