One of the most common and contentious questions we hear as real estate tax experts is, “When should I put my building in service?”
The in-service date is crucial because once the building is in-service, the taxpayer can begin taking depreciation deductions using the partial asset disposition (PAD) opportunity under §168, and for non-residential properties, use 179 deductions.
Let’s look at the rules given to us by the IRS.
§167(a) allows the depreciation deduction for buildings used in the taxpayer’s trade or business. This is a use-it-or-lose-it deduction. Some taxpayers want to “save money” when they sell, so they choose not to take depreciation at all. Their thought process is, “If I don’t take it, I don’t have to pay it back.”
Guess what? Even if you don’t take a depreciation expense, it still has to be paid back at 25% upon the sale of the asset. So take it!
§1.167(a)-10(b) is very clear that the beginning of depreciation of an asset begins when it is placed in service for its intended use and ends when the asset is retired from service.
‘You begin to claim depreciation when your property is placed in service for either use in a trade or business or the production of income. The placed-in-service date for your property is the date the property is ready and available for a specific use”.
A delay of the in-service date will not affect the total dollar amount of the depreciation expense over the asset’s life. An earlier in-service date is desirable, however, because of the time value of money, PADs, bonus depreciation, and Cost Segregation. However, the in-service date can be confusing and can cause many questions.
Here are just a few prevalent questions, along with the answers.
- Does depreciation begin for a building when there is a Certificate of Occupancy?
- A Certificate of Occupancy is generally required before a building is put in service.
- If a building is intended only to protect machinery, like a manufacturing process, can the building be placed in service before the machinery is installed?
- If a building is only built to house a piece of machinery, the building will be placed in service on the date the building is “ready and available to house the machinery and equipment.”
- If a Rental Property is purchased during one tax year but is not rented until the following year, when is the building placed in service?
- As long as the property is ready for its intended use, regardless of whether it’s rented or not, the building can be put in service.
- If a building is moved or relocated, does the placed-in-service date change?
- The IRS ruled that a relocation of a building does not generally cause a new placed-in-service date.
- If a primary residence is converted into an Air B&B, when does depreciation start?
- Suppose a taxpayer converts personal property or a primary residence to use in a trade or business or for the production of income. In that case, the property is placed in service on the conversion date.
- What about renovations?
- An improvement that must be capitalized is treated as a new piece of depreciable property. The recovery period and method of depreciation that apply to the listed property would also apply to the improvement. For example, if you must depreciate the listed property using the straight-line method, you must also depreciate the improvement using the straight-line method.