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

On April 13, 2017, the Internal Revenue Service (“IRS”) issued an official Action on Decision (“AoD”) regarding its defeat in the case of Stine, LLC v. USA (“Stine”).  The case addressed whether a building can be considered “placed in service” before it is “open for business.” Generally, a building is placed in service when it is substantially complete and in a state of readiness and availability to carry out its specified function.  The case of Stine dealt with the question of when a building is considered to be placed in service for purposes of depreciation and the special Gulf Opportunity Zone (“Go Zone”) bonus depreciation.  In the past, the IRS’ general position has been that placed in service is the same as open for business.  In this particular case, the IRS argued that the taxpayer’s buildings were not open for business prior to the GO Zone allowance deadline of December 31 and as a result not yet placed in service.

The facts were as follows: In 2008, the taxpayer constructed two buildings for its retail store operations.  The buildings’ intended use was to sell home building materials and supplies.  The taxpayer was intent on placing the buildings into service in order to apply the Go Zone bonus depreciation benefits within its tax return prior to the Go Zone bonus depreciating expiring on December 31.  The taxpayer elected to apply the Go Zone bonus depreciation on its tax return, which resulted in substantial tax depreciation deductions.  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.  The CO allowed the buildings to store and house equipment, racks, shelving and merchandise and allowed employees to install and stock them; however, the CO did not allow any customers to be on the premises of the retail locations and 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 the Go Zone deadline of December 31; therefore, they were not placed in service.   Based on that reasoning, the IRS disallowed the deductions and assessed additional taxes.  The taxpayer proceeded to pay the tax and then sued for the refund. The U.S. District Court (the “Court”) sided with the taxpayer and allowed the depreciation and the bonus deductions for the two retail locations.  Upon the defeat in Court, the IRS issued the AoD stating that it disagreed with the Court’s decision and will continue to take the same stance in future cases regarding the definition of when a building is considered placed in service.

The seminal question in the Stine case is: When is a building deemed to be placed in service for the purpose of depreciation?  The Internal Revenue Regulations’ definition of when a property is placed in service has been around for decades and has been litigated in the past. However, the litigation to date 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.”  When applied to a building, the regulations state that “in the case of a building, it will ordinarily be placed in service when it is substantially complete and … is in the condition or state of readiness and availability for a specifically assigned function [emphasis added].”   The regulations 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 in the AoD 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.  All of the government’s cited cases were analyzed by the court and found to be inapplicable in the instant case because they did not address the facts in the case. It is worth noting that when asked about the legal authority to equate “open for business” to “placed in service,” during oral arguments, the IRS candidly admitted that no such authority “currently exists” as applied to regular buildings. The IRS, in support of its AoD, reiterated the distinguished cases and added several other cases dealing with power plants. To further support its position, the IRS also cited its Revenue Procedures outlining five factors to consider in determining that a power plant is placed in service.

In Stine, the question was not about the power plant or a building that was not indistinguishable from the machinery that it is intended to contain, and the use of the building “is so closely related to the use of the machinery …that it clearly can be expected to be replaced or retired then the property it initially houses is replaced or retired; the determination of the readiness or availability of the building shall be made by taking into the account the readiness of such machinery or equipment.”But when a regular building, such as a factory mentioned in the regulation, is “placed into service”.

The IRS’ non-acquiescence appears to be based on the comparison of the building to a power plant. The building housing the power-generating equipment clearly falls under the definition of  a building closely related to the machinery it houses, as in contrast to a building “without regard” to the equipment placed into service.  In addition, the IRS’ non-acquiescence also appears to be based on the argument similar to that of machinery or a non-building structure “placed in service,” such as the “unfinished” airplane in Brown v. Commissioner or the “unfinished” runway in Milton J. Noell Tax Court case.  In Stine, the question is when a building is considered placed into service and not when equipment or a single purpose structure was placed into service.  Therefore, it seems logical from plain reading of the regulations that for the timing of when a plain, regular building is placed in service, even a limited CO will allow it to be placed in service under the regulations and as decided in Stine.