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Depreciation Nit-picks That Could Cost You

  • 23 April 2014
  • Author: Cari Holbrook
  • Number of views: 4234
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Depreciation Nit-picks That Could Cost You

When it comes to your interpretation of tax laws and that of the IRS: a court may decide.  This was a tough lesson learned by Michael Brown, a wealthy life insurance salesman who recently lost a $11.2 million bonus depreciation claim over a seemingly simple oversight.  His story brings to light several lessons for business owners: be aware of the current depreciation laws for business vehicles, interpret them correctly, and choose your words wisely in court.

At issue in Brown’s case (which you can read more about here:  Brown, T.C. Memo. 2013-275) was whether or not his new business airplane was truly “placed in service” within the tax year in which he claimed it (2003 in this case). On the surface, Brown seemed to do everything right. He took delivery of the airplane on December 30, 2003; then he flew it on several business trips immediately in an effort to show that it was being used in the waning hours of the year. However, the IRS zeroed in on regulatory language that states property is first placed in service not when it’s first “used” but when it’s in a state of readiness and availability for a “specifically assigned function.” It’s in that last definition that Brown’s case fell apart.

While Brown accepted delivery of his plane and even used it for business within the specified year, he didn’t consider it to be fully functioning for business yet. Shortly after the New Year, Brown sent the plane back for modifications that included a conference table and a large display screen for presentations. As the Journal of Accountancy reports:

“The Tax Court zeroed in on the ‘specifically assigned function’ language, based on Brown’s testimony. Brown testified that the aircraft as delivered on Dec. 30, 2003, ‘was complete in every way except for [the conference table and enlarged viewing screens] that [he] needed.’ Brown made arrangements for those modifications, totaling a bit more than $500,000, to be made in early January 2004. The court opined that it is the taxpayer ‘who gets to determine what an asset’s ‘specifically assigned function’ is.’ At trial, Brown argued that the jet was fully functional for his purpose of business travel when he took possession of it and that his modifications merely made it more comfortable for conducting business. The court, however, noted that his testimony also indicated he considered the modifications to be ‘needed’ and ‘required.’”

While the IRS did not contest a depreciation claim on the plane in general, it did rule—based on Brown’s own testimony—that the depreciation could only be taken for the 2004 tax year, not for 2003. For a business owner with highly fluctuating annual income like Brown’s, that distinction could make a big difference.

This story carries with it several lessons for other business owners:

1.     First, know the current depreciation laws and how they have changed and may change in the near future. Take a look at our recently published Bankler Report on the 2014 inflation-adjusted depreciation limits for business autos, light trucks and vans. While not many business owners travel by private jet, the same rules for “placed in service” apply to all property placed into service for which the taxpayer claims depreciation.  

2.     Then, understand that your interpretation may not match that of the IRS.  As stated above, the IRS does allow the asset owner to determine the asset’s “specifically assigned function.” Once this is established, however, re-interpreting this function as you see fit will likely raise the ire of the IRS. For instance, using a new backhoe for several weeks and then putting it out of service for modifications while you continue to use it may change its “placed in service” date.

3.     Finally, be prepared. Whether in court, deposition, an IRS Audit, or other possible adversarial situations: know exactly in advance what you plan to communicate.  This is perhaps the trickiest of the three lessons, and one that takes expert help and practice to master. Be thoroughly briefed beforehand. Try answering all questions with “yes” or “no.” Do not volunteer any additional information. Let the questioner “pull the information out of you”!  

In the end, it’s always best not wait until the very end of the year to take advantage of large tax depreciation opportunities. Be on the lookout for them throughout the year and plan accordingly.

Image credit: icholakov / 123RF Stock Photo

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