When is Real Estate Placed in Service?

Published Categorized as Depreciation, Federal Income Tax
Property placed in service depreciation, Houston Tax Attorney

Several tax laws are triggered by when property is purchased. Other tax laws are triggered when property is placed in service.

Depreciation on real estate is a good example. It is triggered when property is purchased and placed in service. The capitalized costs are then expensed, usually.

These dates raise questions about whether property is placed in service and sits idle or vacant for years, if not decades, and then is purchased by a new investor and put back into use, when is the property deemed to be placed back in service for the new owner? Is it the date the property is acquired by the prior owner? Is it the date the property is acquired and minimally operational for the new owner? Or is it the date the property is fully up and running for the new owner?

The court addresses the questions in Ampersand Chowchilla Biomass LLC v. United States, No. 2021-1385 (Fed. Cir. 2022) in the context of a power plant and Section 1603 grants. This case and its reasoning are not limited to power plants or Section 1603 grants, however. This is an issue that all real estate investors have to consider.

Facts & Procedural History

This case involves two defunct power plants. They were both inoperable since 1995. They were acquired by a private equity fund in 2007, which also acquired an existing contract to supply power to PG&E.

The plants were located in central California, so needless to say, the plants had to go through a near impossible and expensive bureaucratic process before they could begin operations. This is a good example of private equity pooling resources to realize a profit despite the constraints imposed by trying to do business in California. The fund was able to raise the funds to get the plants operational. The plants operational in 2008 and began selling electricity to PG&E in late 2008. It was operating at 42% capacity in 2008. We’ll come back to this key fact later in this article.

The fund determined that it was not eligible for Section 1603 grants under the American Recovery and Reinvestment Act as the plants were placed in service prior to 2009 or 2010.

A second fund acquired the plants in 2011. It spent $15 million improving the plants and the plants passed emissions tests in late 2011. The new fund applied for $12 million of Section 1603 grants for each plant. The Treasury granted only $1.1 million for each facility, awarded for the additional property that was eligible based on the placed it in service date in 2009 or 2010.

The second fund brought suit in the Federal Court of Claims for an award of the Section 1603 grants. The Federal Court of Claims found for the Treasury, concluding that the plants were already placed in service. The appeals court had to decide whether the plants were placed in service.

What is the “Placed in Service” Date?

The Section 1603 grants look to the “placed in service” date. This is the same date provided in Section 168 for depreciation. Outside of Section 1603 grants, taxpayers and the IRS often dispute when property is placed in service. There are times when taxpayers and the IRS argue that this date is sooner or later, depending on which produces the least or most tax liability.

Bonus depreciation is an example. Real estate investors often argue that property is placed in service sooner to trigger bonus depreciation. The IRS on the other hand often makes the opposite argument. A good example of this is the Brown v. Commissioner, T.C. Memo. 2013-275 case. The Brown case involved an insurance agent who basically tried to placed a jet in service on the last day of the year.

Another example is Stine, LLC v. United States, No. 13-03224, 2015 WL 403146 (W.D. La. 2015). In Stine, the court concluded that a calendar-year taxpayer who purchased a building to be a retail store had placed the building in service in 2008 given that it had received a certificate of occupancy for the building on December 31, 2008.  The IRS issued AOD 2017-02, 2017-15 I.R.B. 1072 in response to the Stine case.  The IRS’s AOD argues that the court erred in holding that the taxpayer’s intended use for the buildings was to “house and secure racks, shelving and merchandise” as stated in the certificate of occupancy.  The IRS reasoned that the taxpayer in Stein was to operate a retail store and the building was not yet ready to be a retail store in 2008.  

What is the Specifically Assigned Function?

In the present case, the question was whether the plants were placed in service in 2009 or 2010 as required for Section 1603 grants.

The rule for Section 1603 grants is similar to the rule for depreciation stated in Treas. Reg. § 1.167(a)-11(e)(1)(i). Specifically, the regulation for Section 1603 says that property is placed in service when it is ready and available for its intended purpose.  The regulation says that this is when property is “placed in a condition or state of readiness and availability for [its] specifically assigned function.”

The Treasury read this language broadly and argued that the plants’ specifically assigned function was to produce and sell electricity. The taxpayer read this language narrowly and said that the plants’ function was to generate at their specified capacity levels while meeting environmental compliance requirements.

The Treasury did not have to argue that the plants are in California so the taxpayer would never be able to operate at peek capacity or meet environmental compliance requirements given the California legal and regulatory system. The trial court concluded that the function was to produce and sell electricity. It reached this decision by applying the factors other courts have considered for this issue:

  1. The necessary permits and licenses for operating have been obtained.
  2. All critical tests necessary for proper operation have been performed.
  3. The unit has been placed in the control of the taxpayer by the construction contractor.
  4. The unit has been synchronized with the transmission grid.
  5. Daily operation of the unit has begun.

Based on these factors, the trial court concluded that the plants were placed in service in 2008.

The appeals court approved the use of the five-factors noted above in siding with the Treasury:

The Court of Federal Claims did not clearly err in its analysis of factor five. The facilities were generating and selling a substantial amount of electricity in 2008. While the facilities occasionally shut down, the Court of Federal Claims did not clearly err in finding that they nonetheless operated regularly.

Thus, the taxpayer was not able to convince the courts that it should receive the additional grants.

The Takeaway

The placed in service date can lead to disputes between taxpayers and the IRS. This case is an example of that. The case also provides a bright line rule for power plants. Those producing electricity are placed in service even if they are taken offline periodically. It is not clear whether this same concept applies to real estate, such as a vacant commercial building that is purchased, rehabbed and placed in service. The depreciation laws use similar language; however, the intent of the statutes for this grant and depreciation differ. A court might reach a different decision if this case involved deprecation rather than specifically-targeted grants. Nevertheless, real estate investors who acquire previously-used property should study this case as they consider when their property is placed in service.

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