Depreciation and Section 179 deductions are valuable tools to lower your taxable income. For 2017, qualified new (not used) assets are eligible for 50% first-year bonus depreciation. In addition, the maximum Section 179 deduction is $510,000, including the cost of qualified real property improvements. These deductions, however, are subject to an important restriction known as the placed-in-service rule.
In general, an asset is considered placed in service for tax purposes when it’s in a condition or state of readiness and availability for a specifically assigned function. Usually this equates to the time when actual business use of the asset begins. However, there may be times when an asset can be considered placed in service before actual business use begins if it’s devoted to the taxpayer’s business and ready for use should the occasion arise.
The placed-in-service rule can be particularly tricky when it comes to real estate. The following guidelines should be considered:
- Residential rental real estate (such as an apartment project) is considered placed in service on the date it is available for occupancy. That is usually the date the certificate of occupancy is received, assuming some marketing efforts have been made.
- Nonresidential rental real estate (such as an office building or shopping center) is usually placed in service on the date the certificate of occupancy is received for the first tenant space.
- A factory building (or other building intended to house machinery and equipment) is generally considered placed in service when it is substantially complete and is in a state of readiness and availability. It does not matter if items of machinery and equipment are not yet in the building or placed in service, except when: (1) the building is itself essentially an item of machinery or equipment or (2) use of the building is so closely related to use of the machinery or equipment that it could clearly be expected to be replaced or retired when the machinery or equipment is replaced or retired.
In a recent case, a Louisiana District Court concluded that retail store buildings were placed in service when they were ready and available for their intended use (to store and house equipment, racks, shelving, and merchandise). Although the certificates of occupancy for the buildings did not permit customers at that time, the buildings were substantially complete and in a condition of readiness and availability to perform the function for which they were built. The IRS disagrees with this decision and will continue to litigate its position that a retail store is placed in service when it is actually ready and available for regular operation and income-producing use.