Case — Asset In-Service Date

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TL Case Summ

THE QUESTION

When is equipment placed in service for purposes of claiming depreciation under Section 179?

THE DISPUTE

Taxpayer Says: Equipment purchased in 2002 and 2003 was not placed in service until 2004 and that is the year the Section 179 depreciation deduction should be claimed.

Internal Revenue Service Says: The equipment was placed in service in 2002 and 2003. The Section 179 deduction should not be claimed in 2004.

THE LAW

From Internal Revenue Code Section 167: Provides for a depreciation deduction for the exhaustion, wear and tear, or obsolescence of property used in a trade or business.

From Internal Revenue Code Section 179(a) and (b): Allows a taxpayer to elect to deduct as a current expense, within certain dollar limitations, the cost of property acquired by purchase for use in the active conduct of a trade or business in the year such property is placed in service.

From Federal Tax Regulation 1.167(a)-10(b): The period of depreciation begins when the asset is placed in service.

From Federal Tax Regulation 1.167(a)-11(e)(1)(i) and 1.179-4(e): “Placed in service” means the time property is first placed by the taxpayer in a condition or state of readiness and availability for a specifically assigned function, whether for use in a trade or business, for the production of income, in a tax-exempt activity, or in a personal activity.

Armstrong World Indus., Inc. v. Commissioner, 974 F.2d 422, 430 (3d Cir. 1992): Individual components are treated as a single property for tax purposes when they are functionally interdependent.

THE CAUSE OF THE DISPUTE

One stipulation for claiming a depreciation deduction is that assets you buy for your business must be “placed in service” before you can start depreciating them. According to nonauthoritative IRS documentation (FSA 199916040), “placed in service” generally means you’ve installed the assets and are using them in your business operations. Assets may also be considered placed in service when they are ready and available to actually be used.

In a situation where equipment is made up of various components, the components typically meet the “placed in service” requirement when they are functionally ready to perform their intended purpose.

In this case, the dispute arises over the question of whether equipment was ready to be used when it was purchased, or at a later date when individual components were interconnected.

The taxpayer bought computer and musical equipment for his studio recording business during 2002 and 2003. He tested individual components of the equipment in those years, but did not connect the components to each other until 2004. Taxpayer believes 2004 is the proper year to claim a Section 179 depreciation deduction for the equipment because that is when the equipment was functional and business use began.

The IRS says the act of testing the equipment means it was ready and available for its specifically assigned function. Since the testing occurred in prior years, 2004 is not the correct year to claim the Section 179 deduction.

WHAT WOULD YOU DECIDE?

Make your selection, then see “The Court’s Decision” below for a full explanation

For the or for the

THE COURT’S DECISION

Download (PDF, 11KB)

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HL Carpenter, an experienced investor and a CPA, specializes in reader friendly articles on taxes and investing for individuals and small businesses, and publishes two newsletters: Taxing Lessons and Top Drawer Ink. Visit TaxingLessons.com and HLCarpenter.com.

This information should not be considered legal, investment or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment or tax advice. Always consult your legal, investment and/or tax advisor regarding your personal situation.

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Right answer!
Sorry, wrong answer :(
For the taxpayer. Regardless of the amount of testing petitioner performed on each individual component, the equipment was not capable of performing its assigned function until interconnected. The equipment purchased in 2002 and 2003 was placed in service in 2004.
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