“Don’t count your chickens before they hatch” is an adage that reminds us to be wary of putting our hope in something that has not yet happened. This phrase is especially true when it comes to depreciation. Although when depreciation begins on an asset may not always be clear, the consequences of an early start could still be severe. Therefore, it is important to understand what it takes to place an asset in service for tax purposes.
When Depreciation Incubates
Typically, depreciation on an asset begins as soon as it is placed in service. Property is considered to be in service when it is ready and available for a specific use. This definition may sound simple, but some people mistakenly assume that they can start depreciating the asset when they purchase it. Think of those purchases that happen at the end of the year when a business owner or manager decides to invest some surplus budget in a new piece of equipment. It is possible to order and pay for the machinery in December but not take delivery until January or February. For tax purposes, there is no deduction until the hardware is ready and available for use. If the business spent much of that surplus cash up front to buy the equipment but they don’t receive the corresponding depreciation deduction on that equipment, then the company could wind up short on funds when it comes time to pay taxes on the income from that better-than-expected year.
The “Feathers” of Early Depreciation
By contrast, sometimes depreciation begins sooner than anticipated. In the next few years, businesses will have an added incentive to make sure that assets are placed in service before year-end; the percentage available for bonus depreciation will be 100% (full-expensing) through 2022 but then gradually decreases from 2023-2026.
This type of tax planning is relatively straightforward for assets with an easily determinable placed-in-service date. But what about an asset under construction, such as a large machine? Does a building need to be open for business to be placed in service?
A recent Louisiana district court case decision allowed business owners to benefit from an earlier placed-in-service date. The case involved a retailer that had substantially completed construction on a new store by the end of the year, but the location was not open to customers. The court held that the building’s “specific use” was to “store and house equipment, racks, shelving, and merchandise.” The judge pointed out that that “placed in service” does not necessarily mean “open for business.” The earlier placed-in-service date qualified the building for an expiring credit, resulting in a $2 million difference in federal taxes in the year that depreciation started. While the IRS announced that it disagrees with this court decision and may litigate this issue in the future, this court case does lay out the framework on how a building owner could argue an earlier placed-in-service date.
Count Your Eggs According to the Right Placed-in-Service Rules
With bonus depreciation thresholds at an all-time high, and eventually disappearing, it is best to start “hatching” plans for large asset purchases or construction projects as soon as possible. Doing so may allow you to place them in service at a time of maximum tax advantage. Your business can understand and comply with the rules more effectively if you have a good advisor. Contact CRI to help you put your eggs in the right baskets.