Could Depreciation Begin on Your Brick-and-Mortar Before You Open for Business?

Real estate is top of mind for many retailers in 2015. While some brands are rethinking store formats and rightsizing the number of stores, others are expanding rapidly or exploring a brick-and-mortar presence for the first time.

As retailers consider real estate decisions and potential investments, in addition to looking closely at locations and consumer trends, retailers should be thinking ahead to how they might account for depreciation.  A recent district court case in Louisiana (Stine, LLC v. USA) may provide some guidance. The case addressed whether a building can be considered “placed in service” before it is even open for business.  Retailers should pay attention to this case, as depreciation can be considerably impacted by the placed in service date.

Generally, a building is “placed in service” when it’s substantially complete and in a state of readiness and availability to carry out its specified function.  Although the definition of “placed in service” can be relatively ambiguous, the IRS’s Audit Technique Guide for Rehabilitation Tax Credits indicates that receiving a certificate of occupancy serves as evidence that a retail location is, in fact, available for its intended use.

In this particular case, the taxpayer built two retail stores but did not open them for business by the end of the tax year. The stores were substantially complete and in a condition of being able to perform the functions for which they were built.  A limited certificate of occupancy had been issued, allowing the buildings to receive equipment, shelving, racks, and merchandise; however, customers were not allowed to enter the stores.

The IRS argued that because the buildings were not open for business, the taxpayer did not place the buildings in service during the year and, therefore, did not qualify for the depreciation deduction in question. But the court did not agree, ruling there is no “open for business” requirement.  For instance, in a prior rulingWilliams v. Commissioner, the taxpayer’s business was not considered placed in service even though it was open for business, until the building’s required refurbishments were complete.  For Stine, the court viewed the certificate of occupancy as the key factor in determining when the building should be considered placed in service.

Note that the court did not address when equipment is placed in service, but stated there is a marked difference in how the tax courts determine when a building—as opposed to equipment and assets—are placed in service.

As retailers open new stores, they should consider this ruling—along with their own specific fact pattern—in order to determine the placed-in-service dates for buildings.  It may significantly affect timing for depreciation claims.

A version of this post appeared on BDO Selections, the blog of BDO’s Restaurant practice.