Retail buildings placed in service before being open for business

A U.S. district court in Louisiana held that buildings to be used as retail stores did not have to be open for business to the public to have been placed in service for depreciation purposes. As a result, the taxpayer was entitled to an accelerated depreciation allowance under the Gulf Opportunity (GO) Zone Act of 2005.

Facts: Stine LLC operates retail stores that sell home building materials and supplies. In its 2008 tax return, Stine took the GO Zone allowance—an immediate 50% depreciation allowance for nonresidential real property placed in service on or before Dec. 31, 2008, for taxpayers affected by Hurricanes Katrina and Rita—on two buildings constructed within the applicable zone. Certificates of occupancy had been issued for both buildings prior to Dec. 31, 2008, for the purpose of installing equipment, shelving, and racks and to allow personnel to begin stocking merchandise. The buildings, however, were not open for business before Dec. 31, 2008, and the certificates of occupancy did not permit the public to enter the buildings.

Issues: The sole issue was when the buildings were placed in service. The taxpayer argued that the buildings were substantially complete and available for their intended use—to house equipment, racks, shelving, and merchandise—by the Dec. 31, 2008, deadline. Stine pointed to the certificates of occupancy granting limited access to the buildings as evidence of their placed-in-service date. The IRS took the position that, since the stores were not open for business, the taxpayer failed to meet the placed-in-service deadline and was thus not entitled to the GO Zone allowance.

The GO Zone Act states that the GO Zone allowance (Sec. 1400N(d)) is governed by Sec. 167 and the related Treasury regulations. Under Regs. Sec. 1.167(a)-10(b), the period for depreciation begins “when the asset is placed in service.” Regs. Sec. 1.167(a)-11(e)(1)(i) provides that property is placed in service when:

[F]irst placed in a condition or state of readiness and availability for a specifically assigned function, whether in a trade or business [or] in the production of income. … In the case of a building which is intended to house machinery and equipment and which is constructed, reconstructed, or erected by or for the taxpayer and for the taxpayer’s use, the building will ordinarily be placed in service on the date such construction, reconstruction, or erection is substantially complete and the building is in a condition or state of readiness and availability.

Citing three court opinions, the IRS argued that case law instructs that a building used in a retail operation must be open for business to satisfy the placed-in-service requirement. The court indicated it would not rely on the first case cited by the IRS, Brown, T.C. Memo. 2013-275, because it involved bonus depreciation for an airplane, not a building, and it was not final (see “Tax Matters: Tax Court Addresses ‘Placed in Service’ Date,” JofA, April 2014, page 61).

Sealy Power, Ltd., 46 F.3d 382 (5th Cir. 1995), addressed whether component parts of an electric power generating plant functioned as a single depreciable property or as multiple, interdependent depreciable units. The court found that the reasoning from the Sealy Power case did not apply in Stine’s situation because the case involved a power generating facility rather than a building that houses merchandise, shelving, and racks and functions as a retail operation.

Likewise, the court dismissed the IRS’s reliance on Piggly Wiggly Southern, Inc., 84 T.C. 739 (1985), because that case addressed whether certain equipment, as opposed to a building, was placed in service for purposes of the investment tax credit. As the court remarked, its precedent and relevant statutory authority clearly distinguished between equipment and buildings for purposes of determining when an asset is placed in service.

To rebut the IRS’s contention that a retail business must be open for business to satisfy the placed-in-service requirement, the taxpayer cited Williams, T.C. Memo. 1987-308. In Williams, the taxpayer argued that its mechanic shop was placed in service when it opened for business for occasional auto repairs, even though the building was still undergoing substantial renovations. The Williams court concluded that whether the shop was open for business was irrelevant. Instead, the important inquiry was whether the building renovations had been substantially completed.

Stine contended that the Williams decision was consistent with Prop. Regs. Sec. 1.168-2(e)(3), which states:

For purposes of this section, a building shall be considered placed in service (and, therefore, recovery will begin) only when a significant portion is made available for use in a finished condition (e.g., when a certificate of occupancy is issued with respect to such portion). [Emphasis added.]

Stine also pointed to the IRS’s Audit Techniques Guide for the rehabilitation tax credit, which provides guidance for rehabilitated buildings under Sec. 47 and which states that a ” ‘Certificate of Occupancy’ is one means of verifying the ‘Placed in Service’ date for the entire building (or part thereof).”

Holding: The court concluded that the buildings had been placed in service prior to the Dec. 31, 2008, deadline and that the taxpayer was entitled to take the accelerated depreciation allowance under the GO Zone Act of 2005. The court concluded that there was no authority to support the IRS’s position that “placed in service” means “open for business.” Instead, the appropriate inquiry is whether a building is in a condition of readiness and availability to perform the function for which it was built—in this case, to house racks, shelving, and merchandise.

• Stine, LLC, No. 2:13-03224 (W.D. La. 1/27/15)

—By Gary Sanders, J.D., clinical assistant professor of business law and accounting, and Darlene Pulliam, CPA, Ph.D., Regents Professor and McCray Professor of Accounting, both of the College of Business, West Texas A&M University, Canyon, Texas.