The 2013 Tax Court decision in Michael D. Brown and Mary M. Brown v. Commissioner of Internal Revenue, stressed the importance of ensuring the proper date is used for placing an asset in service. The Court disallowed the bonus depreciation and regular MACRS depreciation claimed on a plane the taxpayer acquired and used in December of 2003.
The facts of the case include:
The taxpayer (Brown) sold premium insurance policies where the premiums exceeded $10 million. To facilitate his meetings with wealthy clients, he purchased an airplane. The plane was delivered in December 2003 at a cost of $22 million. He used the plane at the end of December and took a bonus depreciation deduction of $11 million, and regular MACRS depreciation on the remaining basis.
However, the taxpayer had the plane modified for items that he had deemed necessary for the business use of the aircraft in January of 2004. The modifications to the plane were contracted for, when the aircraft was originally purchased. The improvements consisted of the addition of a conference table and the replacement of existing display monitors with larger versions for presenting information to potential clients. These alterations to the plane cost in excess of $500,000 and were completed at the beginning of January 2004.
The Tax Court found that the aircraft was qualified property. However, for qualified property to be eligible for bonus depreciation during a tax year, it must have initially been placed in service during that year. The Internal Revenue states “property is first placed in service when it is in a condition or state of readiness and available for a specifically assigned function”.
While the taxpayer had taken possession of the aircraft and used it for business, by the taxpayer’s own admission there were additional modifications required to make the plane complete for his business purposes. Since the modifications did not occur in 2003, the Tax Court concluded that the aircraft was not put into service until 2004, and disallowed the regular MACRS depreciation and $11 million of bonus depreciation taken in 2003.
It important for any taxpayer to consider that the date property is treated as being placed into service is the date that the asset fully meets the business requirements of the enterprise. If an asset is being utilized in a particular year, it does not necessarily mean the asset is placed in service during that year. If assets are being used in the business, but require additional modifications or development in order to fully meet the needs of its ultimate use, the Internal Revenue Service may disallow costs recovered through depreciation or other cost recovery methods until the asset is ready for its intended purpose.
The Internal Revenue Service position and Tax Court decision rely upon the requirements of placing an asset in service as determined by prior case law. This case may be appealed as the additional modifications made to the airplane are de minimis compared to its initial cost as they represent less than 2% of the total cost of the asset.
Contact your Marcum Tax professional with any additional questions or to assist in determining the impact of this decision on you or your business.