'Placed in Service' Does Not Mean 'Open for Business'

Dennis Zinkevich, CPA
Published Date:
Jul 1, 2017

On Apr. 13, 2017, the IRS issued an official Action on Decision (“AoD”) regarding its defeat in Stine, LLC v. United States. Stine addressed whether a building can be considered to be “placed in service”—meaning it is substantially complete and in a state of readiness and availability to carry out its specified function—before it is “open for business” for purposes of depreciation and the special Gulf Opportunity Zone (“Go Zone”) bonus depreciation. The IRS’s general position in the past has been that “placed in service” means “open for business,” and the agency decided in this instance that the taxpayer’s buildings were not open for business prior to the Go Zone allowance deadline of Dec. 31 and, as a result, not yet placed in service.

The facts of the case were as follows: In 2008, the taxpayer constructed two buildings to sell home building materials and supplies for its retail store operations. The taxpayer was intent on placing the buildings in service in order to apply the Go Zone bonus depreciation on its tax return prior the bonus’s expiration on Dec. 31. The taxpayer elected to apply the Go Zone bonus depreciation on its tax return, which resulted in substantial net operating losses that were then carried back. Prior to the end of the tax year, the taxpayer received a limited 30-day Certificate of Occupancy (“CO”) for the building locations in question, which allowed the buildings to store and house equipment, racks, shelving, and merchandise and hire employees to install and stock them. The CO, however, did not allow any customers to be on the premises of the retail locations—thus, the buildings were not open to the public by the end of the tax year.      

Upon audit of the taxpayer, the IRS disallowed the depreciation and the Go Zone bonus, asserting that the buildings were not open for business prior to Dec. 31 and therefore were not placed in service. Based on that reasoning, the IRS assessed additional tax. The taxpayer proceeded to pay the tax and then sued for the refund. The court sided with the taxpayer and allowed the depreciation and the bonus deductions for the two retail locations. The IRS then issued the AoD, expressing disagreement with the court’s decision and stating its intent to take the same stance in future cases regarding the definition of when a building is considered placed in service.

The seminal question in Stine is: When is a building deemed to be placed in service for the purposes of depreciation? Treasury Regulations section 1.167(a)-11(e), which governs the relevant definition of “placed in service,” has been around for decades and has been the subject of past litigation. Litigation to date, however, has not been concerned with regular buildings—under the regulations, the broad definition of when property is “placed in service” is when the property is in “a condition of readiness and availability for a specifically assigned function.” The regulations state that property is placed in service “when first placed in a condition or state of readiness and availability for a specifically assigned function (emphasis added).”  They further state that “in the case of a factory building, such readiness and availability shall be determined without regard (emphasis added) to whether the machinery or equipment which the building houses . . . has been placed in service.”

The IRS cited several cases to support its position that the timing of “placed in service” occurs after the business is “open for business” because a condition of readiness for specifically assigned functions must be satisfied. The court analyzed all of the government’s cited case precedent, but it found them to be inapplicable to Stine—they did not address the specific facts of the case. When asked about the legal authority to equate “open for business” to “placed in service” during oral argument, the IRS candidly admitted that no such authority “currently exists” as applied to regular buildings. Rather, the IRS, in support of its position, reiterated its reliance on precedent, including several cases dealing with power plants. The IRS also cited Revenue Ruling 76-256 and Revenue Ruling 76-428, which outlined five factors to consider when determining whether a power plant has been “placed in service.”

But in Stine, the question was not about the power plant or a building whose use “is so closely related to the use of the machinery” that “the determination of readiness or availability of the building shall be made by taking into the account the readiness and availability of such machinery or equipment.” Rather, it was a regular building. The IRS’s position, however, appears to be based on comparing the building to a power plant, although the building housing the power-generating equipment clearly falls under the category of buildings closely related to the machinery it houses.

The IRS’s position also appears to be based on cases involving machinery or a non-building structure “placed in service,” like the “unfinished” airplane in Brown v. Commissioner or the “unfinished” runway in Noell v. Commissioner. In Stine, however, the question is when a building is considered placed into service—not when equipment or a single purpose structure was placed into service. After Stine, it seems that the IRS will take the position that even a limited CO will allow a plain, regular building to be considered placed into service.

DennisDennis Zinkevich, CPA, has over 18 years of tax experience in advising wide range of clients in real estate and high technology space. He has BS from Brooklyn College and MS in Tax from Pace University. He can be contacted at denniszin@yahoo.com.

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