On April 10, 2017, the Internal Revenue Service (IRS) announced in Action on Decision (AOD) 2017-02 that it disagrees with the decision reached by the US District Court for the Western District of Louisiana in Stine, LLC v. United States, which concluded that, for a building housing a retail store, the store does not need to be open for business to the general public for the building to be considered placed in service.¹

Placed-in-service requirement

For purposes of both depreciation under Section 167 and the investment tax credit under Section 46, property is considered placed in service when it is in a condition or state of readiness and availability for a specifically assigned function. For a building that is intended to house machinery and equipment and is constructed, reconstructed or erected by or for the taxpayer and for the taxpayer's use, Treas. Reg. Section 1.167(a)-11 provides that the building will ordinarily be placed in service on the date the 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 is be determined without regard to whether the machinery or equipment that the building houses, or is intended to house, has been placed in service.

Stine, LLC v. United States

In 2008, the taxpayer, a building materials and supplies retailer, constructed two new buildings to be used in its retail operations. Both buildings were located in the Gulf Opportunity Zone and would qualify for 50% bonus depreciation if deemed to be placed in service before January 1, 2009. Although the retail locations were not yet open to the general public, the taxpayer argued that the buildings were considered placed in service when they were substantially complete and ready and available for their intended use to store and house equipment, racks, shelving and merchandise. This was evidenced by the certificates of completion and limited occupancy that were issued before December 31, 2008. The IRS argued that the two buildings were not "open for business" before January 1, 2009, because they were not placed in service in 2008. The district court ruled in favor of the taxpayer, stating that the IRS failed to cite any authority to support its argument of an "open for business" standard for determining when a building is placed in service.

AOD 2017-02

Under AOD 2017-02, the IRS formally rejected the district court's ruling in Stine, stating that the court erred in holding that the taxpayer's intended use of the buildings was to house and secure racks, shelving and merchandise. Rather, the IRS stated that the taxpayer intended to use the buildings as retail stores, so the taxpayer must show the buildings were ready and available for that use. Furthermore, the IRS stated that, in order for the buildings at issue to be considered ready and available for their specifically assigned function (i.e., placed in service), they must be ready and available for regular operation and income-producing use. To this latter point, the IRS pointed to certain factors identified in determining when an electric power plant is placed in service as factors indicative of a building's readiness and availability for its intended use, such as:

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

Implications

Determinations associated with an asset's placed-in-service date become particularly relevant when considering certain provisions set forth in the Protecting Americans from Tax Hikes (PATH) Act of 2015. Under the PATH Act, 50% bonus depreciation was extended for property placed in service during 2015, 2016 and 2017, but decreases to 40% in 2018 and 30% in 2019 before being entirely phased out in 2020.² Additionally, the PATH Act expanded the definition of property eligible for bonus depreciation to include qualified improvement property (QIP). QIP is defined as any improvement to an interior portion of a building that is non-residential real property if the improvement is placed in service after the date the building was first placed in service.

As a result of the IRS's indication that it will use an "open for business" standard to determine when a building is placed in service, application of these taxpayer-favorable provisions of the PATH Act may now be at risk of heightened IRS scrutiny. Taxpayers citing Stine, LLC v. United States as authority for the placed-in-service requirement for buildings should anticipate IRS challenges to their positions, especially when taking into account the phase-down of bonus depreciation and the determination of QIP.

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ENDNOTES

¹ Stine, LLC v. U.S. ex rel. IRS, No. 13-03224, 2015 WL 403146 (W.D. La. Jan. 27, 2015).

² Note that long-production period property and certain aircraft, as described in I.R.C. Section 168(k)(2)(B) and (C), respectively, are generally provided an additional year in order to be placed in service and still qualify for bonus depreciation under the various bonus depreciation provisions/percentages.