Federal Tax Alert - July 2017

July 2017

IRS Takes an "Open For Business" Approach Regarding When a Retail Store is Placed in Service

The Internal Revenue Service announced its non-acquiescence to the  U. S. District Court of the Western District of Louisiana’s holding in Stine, LLC v. United States, No. 2:13-03224 (W.D. LA 2015 ) (“Stine”), which previously held that retail stores were placed in service when substantially complete.  The IRS has stated that it will continue to assert that a retail building must be “open for business” to be considered placed in service. 

The court in Stine held that the buildings that were built to operate as retail stores were placed in service when substantially completed to house and secure racks, shelving, and merchandise.  In Action on Decision (“AOD”) 2017-2, the IRS formally announced that it will not follow this court decision and maintains that a retail store is placed in service for depreciation purposes when the building is ready and available to operate as a retail store; in other words, when the store is open for business.    



Background

Assets are not eligible to be depreciated until they are placed in service.  The Income Tax Regulations state that property is placed in service on the date when it is “in a condition or state of readiness and availability for a specifically assigned function.”[1]  All relevant facts and circumstances should be considered to determine 1) the specifically assigned function of the property, and 2) when that property is ready and available for the specifically assigned function.

In Stine, the taxpayer operated retail stores selling building materials and had constructed two new buildings it considered placed in service by December 31, 2008.  The taxpayer faced a statutory sunset of December 31, 2008, to qualify for additional first-year depreciation under the Gulf Opportunity Zone legislation.  As of December 31, 2008, the buildings had received 30-day certificates of occupancy that allowed them to receive equipment, shelving, racks and merchandise, as well as allowed the appropriate personnel to install and/or stock those items.  However, the stores were not yet open for business on December 31, 2008, and certificates of occupancy did not allow customers to enter the stores.  The district court held that the buildings were in a state of readiness and available to perform their function of housing shelves, racks, merchandise and equipment.  As such, this was sufficient for the buildings to be placed in service.   In its AOD, the IRS formally disagreed with the court and stated that it will not follow the court’s ruling.  The IRS and the court differed in their interpretation of the test for determining the placed in service date.

In Stine, the court reasoned that the specific function of the buildings in question was to “house and secure racks, shelving, and merchandise,” and that since the certificates of occupancy allowed those activities as of December 31, 2008, the building had been placed in service.  The IRS disagreed and stated that the court should have determined the true specific function of the buildings in the context of the taxpayer’s trade or business - to make retail sales to the public.  Also, the IRS stated that the court should have held that the property was placed in service when it was ready and available for regular operation.  The certificates of occupancy did not allow customers to enter the buildings.  Therefore, the IRS contended that the buildings could not be placed in service until the stores opened for business. 

In its announcement rejecting the rationale of the Stine decision, the IRS stated that it will continue to take the position that, under Treas. Reg. § 1.46-3(d)(1)(ii), a retail store is placed in service for depreciation purposes when the building is ready and available to operate as a retail store.  The IRS will assert that a retail store’s ability to begin operations is determined under the following four factors of Revenue Rulings 76-256 and 76-428 (these Rulings dealt with electric power facilities and contained a fifth factor specific to power plants, but the IRS appears to be applying them broadly across industries, including retail sales):
 
  1. approval of all required licenses and permits,
  2. passage of control of the facility to the taxpayer,
  3. completion of critical tests, and
  4. commencement of daily or regular operations.[2]



BDO Insights

The court’s ruling in favor of the taxpayer in Stine would suggest that buildings that are substantially complete but not yet open for business can be considered “placed in service” for purposes of both regular depreciation and bonus depreciation.  However, the IRS has indicated that they will challenge this position and continue to litigate against taxpayers who do not use the “open for business” standard.

Certain qualified assets placed in service on or before December 31, 2017, are eligible for 50-percent bonus depreciation.  Under current legislation, the bonus depreciation percentage drops to 40-percent for property placed in service in 2018 and to 30-percent for property placed in service in 2019, and then, with few exceptions, expires.[3]  Accordingly, the determination of placed in service dates is critical for maximizing depreciation deductions and may lead to challenges from the IRS. 

Given the significance of depreciation deductions and the forthcoming phase-out of bonus depreciation, taxpayers should think critically about depreciable assets and the circumstances of placed in service dates for new buildings.  Consulting with a tax advisor can help maximize opportunities for depreciation and navigate the placed in service date requirements.  

The Cost Segregation Services Team within the BDO Fixed Assets Advisory group consists of professionals experienced in building design, construction, cost estimating, and relevant tax authority and can help owners of business real estate assets increase cash flow by accelerating federal tax depreciation through engineering-based cost segregation studies.
 

For more information, please contact one of the following practice leaders:
 
Mark Zettell
Tax Managing Director
  Duane Dunlap
Tax Senior Manager

 
Yuan Chou
Tax Managing Director
  Marla Miller
Tax Managing Director

 
 
 
[1] Treas. Reg. § 1.167(a)-11(e)(1)(i), also referencing § 1.46-3(d)(1)(ii).
[2] Action on Decision 2017-2, referencing Rev. Rul. 76-256 and 76-428.
[3] Public Law 114-113, § 143.