When Should a Rental Property Be Placed in Service for Tax Purposes?

The IRS allows depreciation tax deductions for qualified property that is used in the taxpayer’s business, or held for the production of income when a property is placed in service. The date a property is placed in service can be particularly important under the current tax rules allowing 100% bonus depreciation on certain types of property. (Note: Cost segregation studies can provide strategies to increase the amounts in certain property classes that are eligible for bonus depreciation.)

When a rental property undergoes extensive development before it is available for the production of income, the exact date when the property is placed in service can be tricky, especially if the project has multiple milestone dates to consider. The IRS considers the property placed in service when the following three elements are all provided:

1. Readiness
2. Availability
3. Capability to perform its intended function

Readiness generally means that the rental property is habitable and legally able to be rented. A taxpayer can generally claim that a rental property is ready if the property either receives, or is ready to receive, a Certificate of Occupancy (CO) by a state or local authority. The rules regarding a CO can vary between different localities; however, if the property is legally allowed to be occupied it should meet the readiness requirement.

Availability generally means that the rental property is advertised to be rented. The property does not need to have a signed lease, as long as it is available to be rented and there is some attempt to make it known to the market. (Note: Advertising can be word-of-mouth advertising or something as simple as a “FOR RENT” sign with a contact number posted on the property. Documentation of attempts to advertise the property to the marketplace are helpful to demonstrate the position that the property was available.)

Capability to perform its intended function is emphasized by the IRS and has been interpreted differently between the courts and the IRS in the past. Many taxpayers take the position that a rental property is capable of performing its intended function when it is made available to be turned over to a tenant when a property is improved in accordance with a specific lease. In the Stine, LLC v. U.S. case, 2015 U.S.T.C. Par. 50172 (W.D. LA. 2015), the courts agreed with this logic. The IRS argued in Stine that a retail store was not capable of performing its intended function until the retail store was open to the public.

After Stine, the IRS has stated that it disagreed with the court’s decision and maintains that a property is only capable to perform its intended use when it is open to the public. This position of the IRS should be taken into account when evaluating the placed-in-service date you should use.