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'Bought' isn't the same as 'placed in service'

November 24, 2009

Deductions for fixed assets -- depreciation and Section 179 deductions -- don't necessarily start when you buy an asset. They are only available when the asset is "placed in service." This can be a weapon for the IRS to delay deductions for assets that may be on the premises, but haven't been put into operating shape.

A taxpayer yesterday showed the IRS that trick can work both ways. Courtney Brown was an electrical engineer with a specialty in recording equipment and dreams of going into business. He bought some equipment and tinkered with it for months. Finally he felt it was working the way he wanted in 2004, so he quit his day job and opened his own recording studio. He claimed a Section 179 deduction -- the deduction that enables taxpayers to write off currently equipment costs that otherwise can only be recovered over a period of years through depreciation -- of $22,832 for his equipment.

The IRS came auditing, and things ended up in Tax Court:

Petitioner purchased the equipment from 2002 to 2004 for use in his studio recording business. Petitioner contends that the equipment was not used until 2004 and was therefore placed in service that year.

Respondent contends the equipment was placed in service in 2002 and 2003 because petitioner tested some pieces of equipment before 2004. Respondent argues that the equipment was thus ready and available for its specifically assigned function at that time. We agree with petitioner.

Judge Gerber explains the rules (citations omitted):

Individual components are treated as a single property for tax purposes when they are functionally interdependent. Regardless of the amount of testing petitioner performed on each individual component, the equipment was not capable of performing its assigned function until interconnected and capable of supporting the operation of the studio. Each piece of equipment was thus essential to the operation of the studio as a whole and was not useful or able to be used to operate a business by itself.

That's a taxpayer victory here, but it also implies a warning to taxpayers: if your machinery is still in shipping crates needing to be put together at year-end, it's probably not yet eligible for depreciation or Sec. 179 deductions. If you want the deduction this year, get it out of the box and hook it up!

Cite: Brown, T.C. Summ. Op. 2009-171

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