Depreciation: Understanding "Placed In Service"

A pivotal factor in determining whether a depreciation deduction (bonus or otherwise) may be taken in a particular year is whether the asset for which the depreciation deduction is sought, has been "placed in service" by the last day of the year. The U.S. Treasury Department has interpreted this "placed in service" requirement to mean that the asset is "in a condition or state of readiness and availability for a specifically assigned function."

In 2013, the U.S. Tax Court (Brown v. Commissioner,T.C. Memo. 2013-275) denied a taxpayer 50 percent bonus depreciation on a $22 million airplane he purchased and took delivery of on December 30, 2003, and used to fly to various locations on December 30 and 31, 2003. The court's denial of the significant tax deduction was not because it disbelieved the high-end insurance salesman's claim that he needed the airplane to be able to effectively and efficiently conduct business with both prospects and current clients, nor was it because they disbelieved that the airplane was actually used by December 31. The deduction was denied because the airplane the taxpayer received on December 30 was, pursuant to a prior written agreement between the vendor and the taxpayer, returned to the vendor in early January of 2004, to be modified for the addition of a conference table and larger display screens. Not only were these modifications costly ($500,000), but according to the taxpayer, an airplane without those enhancements was not sufficient to suit his business needs. However, according to the Tax Court, this meant that the airplane received on December 30, 2003, without the enhancements Mr. Brown required to conduct his business, was not "placed in service," even though it was flown for business purposes prior to December 31, 2003, because the airplane at that time was not available for the specifically assigned function of Mr. Brown.

What Does This Mean For You?

As Mr. Brown's case makes clear, buying and using a business asset by the end of the year is not necessarily enough, if you want the asset to be eligible for depreciation. Where you require an asset to have specific features or functionality-even though the asset can work perfectly well "as is"-the asset must have those features or functionality (and be ready for use) before it is eligible for depreciation. Highly customized machinery or vehicles and industry or retail-specific leasehold improvements are examples of the type of assets which might require a closer look at the "placed in service" features before year-end.

Suggested Action

• If you are considering the purchase of a business asset by year-end, in part to claim additional depreciation deductions, make sure the asset you are contracting to buy already fits and meets any unique needs of your business, or

• To the extent an "off-the-shelf" asset will require modification to suit your business needs, make sure to allow enough time for such modifications to be made by the end of the year.

• For year-end purchases, keep records that can prove the asset's use in your business by year-end, and if it is in a state of readiness and availability for its specifically assigned function.

Please contact your Eide Bailly tax professional if you have any questions or need assistance. 

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