Fact Sheet – Property in Service for Cost Recovery
(Depreciation and Section 179 Deduction) Purposes

In order to take an income tax deductions for the recovery of the cost of business property, the property needs to be “ready and available” for the business purpose for which it is intended. In a capital intensive business and/or a business which depends on the use of such property for its underlying business operation, the placement of the property in service may also trigger the deductibility of other business expenses. There is considerable tax authority governing the circumstances under which property will be considered to be ready and available for use. This authority is applicable to conventional depreciation, deductions under Section 179, and bonus depreciation.

Regs. Sec. 1.167(a)-(11)(e)(1)(i) provides that property is considered to be placed in service when it is “first placed in a condition or state of readiness and availability for a specifically assigned function” (emphasis added).

The Service has often interpreted this provision narrowly, requiring full actual operational use, not merely availability for use, of an asset before it is deemed placed in service. FSA 199916040, for example, dealt with a taxpayer that purchased, sold, and transported natural gas. The taxpayer owned and operated an integrated pipeline system, which connected gas supply sources from several states to gas markets in other states. Because compressors were required to maintain gas pressure in the pipelines, the taxpayer bought both new and used compressors. These compressors were repaired if necessary and were placed into warehouses for storage until needed. On their delivery to storage, the taxpayer treated the compressor as having been placed in service for depreciation purposes, presumably on the ground that the machines were ready and available for their assigned function.

In advising against depreciation until the time the compressors were installed in the pipelines, the Chief Counsel noted that the Service has applied Regs. Sec. 1.167(a)(11 (e)(1)(i) generally to require actual operational use in the trade or business, citing Consumers Power Co., 89 TC 710 (1987), and Oglethorpe Power Corp., TC Memo 1990-505, to support this conclusion. In Consumers, the Tax Court implicitly adopted the argument that an asset or facility is not placed in service until it is operating at rated capacity. Relying on Consumers, the court in Oglethorpe stated that an electricity-generating unit should not be deemed placed in service because it was not available for its specifically assigned function, which the court defined as consistently sustaining generation levels near its rated capacity.

The IRS has also taken positions in several revenue rulings consistent with the idea that full operational use of an asset is a prerequisite for it to be considered as placed in service. Rev. Rul. 79-98, for example, states that a nuclear electric generating facility was placed in service when “the unit was able to operate at its rated capacity without failure.”

Similarly, in Rev. Rul. 73-518, the taxpayer, an electric utility company, deducted depreciation on a transmission line in year 1, on the ground that the line was ready and available for its assigned function. The Service, however, ruled that the transmission line was not placed in service in year 1 because substations, which were necessary to put the lines into operation, were not completed and made available for service until year 2.

The Service and the courts have, however, often adopted a less restrictive placed-in-service stance, thereby muddying the waters. In Rev. Rul. 76-238, the IRS responded to a request for advice as to the proper placed-in-service dates for depreciating (1) a building constructed to house manufacturing facilities and (2) the individual items of production machinery and equipment that were to be housed within the building. The Service considered the building to be placed in service on the date its construction was completed and it was made available for installation of machinery and equipment.

Similarly, the Service considered the machinery that was installed in the building over a period of months to have been placed in service when the “entire production line was available for the production of an acceptable product…notwithstanding later testing to eliminate defects which prevented attainment of planned production levels or the meeting of acceptable quality control parameters.” In other words, “availability for a specifically assigned function” in the case of machinery does not necessarily mean that the machinery be put to actual operational use.

Following the principle in Rev. Rul. 76-238, several other revenue rulings have concluded that actual operation use or operation at rated capacity is not a prerequisite for an asset to be deemed placed in service (see, e.g., Rev. Ruls. 76-256 and 84-85).

More recently, Letter Ruling 200334031 responded to a request for a ruling as to when each of several wind turbine generators was placed in service for depreciation allowance purposes and for the renewable energy production credit under Sec. 45. The Service ruled that the turbines should be considered placed in service for purposes of the allowance for depreciation deductions and the renewable energy production credit, notwithstanding any temporarily limited capacity or output.

The ruling cited Regs. Sec. 1.46-3(d)(2), which provides examples of when property is in a condition of readiness. One example covers equipment acquired for a specifically assigned function that is operational but undergoing tests to eliminate any defects. Another example involves operational farm equipment acquired and placed in service in a tax year even though it was not practical to use such equipment for its specifically designed function in the taxpayer’s business of farming until the following year.

In addition to revenue rulings, several court cases also appear to disregard the IRS-imposed general requirement that actual operational use or operation at rated capacity is a precondition for an asset to be deemed placed in service. For instance, in Sealy Power, 46 F3d 382 (5th Cir. 1995), the court held that minimal operation of an electricity generating plant fueled by burning trash is sufficient for the plant to be deemed placed in service.

Likewise, in both Northern States Power Co., 151 F3d 876 (8th Cir. 1998), and Connecticut Yankee Atomic Power Co., 38 Fed. Cl. 721 (1997), the courts allowed depreciation for nuclear fuel assemblies in the year received. The courts reasoned that they were “ready and available” for immediate use on delivery even though the fuel assemblies were not actually installed and supplying power to the reactors until months after delivery in the following fiscal year.

In Sears Oil Co., 359 F2d 191 (2d Cir. 1966), the court concluded that “depreciation may be taken when depreciable property is available for use ‘should the occasion arise,’ even if the property is not in fact in use” (emphasis added). Relying on Sears, the court in SMC Corp., 675 F2d 113 (6th Cir. 1982), held that a fully operational crane and shredder installed by a taxpayer had been placed in service even though a utility company had not yet completed the electrical lines needed to power the equipment.

Thus, the Court of Federal Claims and the Second, Fifth, Sixth, and Eighth Circuits, among others, appear to reject an “actual operation” requirement in this context and to adopt a more expansive standard whereby depreciation may be taken when depreciable property is available for use “should the occasion arise,” even if the property is not in fact in use.

In Livingston, TC Memo 1966-49, the Service argued that depreciation is not allowable on a building under construction that is not yet being used in a business operation. The court rejected this argument, holding that depreciation is allowable on portions of the building from the date such portions became completed for use in petitioner’s business, even if the entire building project is not yet complete.

Based on the foregoing, it is clear that whether a property is considered to be placed in service can often be a controversial tax position. If the property is not actually being used for its intended purpose, the taxpayer will need to determine if it is available for use, and the reasons for any delays between its availability and its actual business use.

If the property is not ready and available for business use, the associated costs may be considered Startup Costs under Internal Revenue Code Section 195. Under this provision, you can deduct up to $5,000 of Startup Costs in the year your business begins operation. The balance of your startup costs can be amortized over 180 months (15 years). Many of the costs of acquiring and preparing tangible business property for use may be capitalized as part of the cost of that property, which may have a shorter service life than 15 years.

If the above authority, in combination with your specific facts, constitutes substantial authority for the deduction, the tax position can be taken without additional disclosure of the circumstances. If, on the other hand, the position is a reasonable position without substantial authority, the taxpayer may be subject to penalties unless they fully disclose the facts and circumstances surrounding the tax position. If there is a reasonable basis for the tax position, short of substantial authority, the taxpayer should fully disclose the circumstances surrounding its selection of the service date in order to avoid exposure to tax penalties. The disclosure would normally included in Form 8275, Disclosure Statement. For more information, see:

This information is provided by Tarlson & Associates, an independent certified public accounting firm which serves individuals, businesses, estates, trusts and nonprofits worldwide. We have significant experience assisting our clients with evaluating their options when hiring employees and engaging contractors.

We make every effort to update this Fact Sheet from time to time to reflect current developments in tax practice. Before you rely on this information, be sure to check with us to see if there have been any recent developments which might affect your situation.

Please let us know if we can be of further assistance in assisting with your accounting and tax treatment of property placed in service in your business.