The IRS has raised concerns about whether property that a taxpayer leases and sells can be depreciated. This is known as the “dual purpose property” issue. A recent IRS pronouncement stated that depreciation of leased property is allowed while it is being leased, but should be discontinued when it is available for sale or lease. However, this conclusion is not supported by the relevant tax law. A previous IRS ruling stated that leased property remains depreciable until it is sold. Depreciation is a tax deduction allowed for the wearing out of property used in a business. If a business both sells and leases the same type of property, the main purpose of how the property is used (selling or leasing) determines if it can be depreciated for tax purposes. This is decided on a case-by-case basis and there are no specific rules for this situation. As a result, there have been a few rulings to determine if depreciation is allowed for businesses that both sell and lease similar property. In cases where the issue of dual purpose property has been litigated, the question is whether a business can claim certain tax benefits when selling property that was previously leased. Courts have consistently held that certain tax benefits do not apply in these situations, even though the business was allowed to claim depreciation on the leased property. One example is Recordak Corp. v. U.S., where the court ruled that the business could not claim the tax benefit, but also acknowledged that the business had properly claimed depreciation on the leased property. In simple terms, the tax law treats property used for both business and selling differently. The specific rules for property used in a trade or business under IRC §1231 are different from the rules for property subject to depreciation under IRC §167. The courts have made decisions in cases like Recordak and Greene-Haldeman about whether certain property can be treated as business property for tax purposes. However, the IRS may not always agree with the courts’ decisions. In a court case, the judge said that a company that sells and rents out equipment can claim depreciation on the equipment even if it’s also available for sale. The court also said that if the company sells the equipment, they have to pay regular taxes on the money they make. This shows that even though the equipment can’t be treated as a long-term investment, the company can still claim depreciation on it. In the first private letter ruling, the IRS determined that a company should depreciate property it leased out, rather than treat it as inventory for sale. The ruling looked at factors like rental terms, lease terms, and the company’s treatment of rental payments.
In the second ruling, the IRS decided that a company’s cushion gas, which served two purposes, should be treated as both inventory for sale and depreciable property for the company’s business use. This was because the gas was used to operate a storage reservoir and could also be sold to customers. In both of these cases, the taxpayer was allowed to include leased equipment in their inventory for tax purposes. This was because their main intention was to sell the equipment, and the leases were just a small part of their business. In another case, the taxpayer was allowed to depreciate all of the equipment they purchased, even though most of it was leased out. This was because their main business was leasing equipment, and it was uncertain at the time of purchase whether the equipment would be sold or leased. A taxpayer can have equipment for both leasing and selling. Whether it’s used for leasing or selling determines if it can be depreciated. If it’s for leasing, it can be depreciated. If it’s for selling, it can’t be depreciated. When leased equipment is sold, special tax rules apply. There’s some disagreement on when depreciation should stop for leased equipment that’s no longer being leased. If you own property that you use for both business and leasing, be sure to keep good records to show that the main purpose of the property is for leasing. You may need to separate your assets for accounting and management to make this clear. This is important because the tax authorities may challenge your depreciation claims for the property. It’s better to be prepared and have good evidence to support your case.
Source: https://www.floridabar.org/the-florida-bar-journal/is-your-clients-leased-property-depreciable-the-irs-may-not-think-so/
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