How does the placed-in-service date affect depreciation for a commercial property owned by a single member LLC when the tenant is another disregarded entity owned by the same individual?
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The placed-in-service date is a critical factor in determining when depreciation begins for commercial property under the Internal Revenue Code. For a single member LLC (SMLLC) that owns commercial property, and where the tenant is another disregarded entity owned by the same individual, the analysis of the placed-in-service date and its effect on depreciation involves several key legal principles and regulatory interpretations.
1. Definition of Placed-in-Service Date
The placed-in-service date is generally the date when the property is in a condition or state of readiness and availability for its specifically assigned function, which, for commercial rental property, is typically when the property is ready and available to be rented or used in a trade or business, not necessarily when it is actually rented or occupied.
- Reg. §1.167(a)-11(e)(1)(i): Property is “first placed in service” when it is first placed in a condition or state of readiness and availability for a specifically assigned function, whether in a trade or business, for the production of income, in a tax-exempt activity, or in a personal activity.
- IRS Publication 946: Depreciation begins when the property is ready and available for its specific use, even if it is not actually being used.
2. Single Member LLCs and Disregarded Entities
For federal tax purposes, a single member LLC is disregarded as an entity separate from its owner unless it elects otherwise. Similarly, if the tenant is another disregarded entity owned by the same individual, both entities are treated as the same taxpayer for federal income tax purposes.
- Result: The lease between the SMLLC and the disregarded entity tenant is ignored for federal tax purposes. The property is considered used by the owner, not leased to a third party.
3. Effect on Depreciation
a. When Does Depreciation Begin?
Depreciation begins when the property is placed in service, i.e., when it is ready and available for its intended use as commercial rental property. The fact that the tenant is a disregarded entity owned by the same individual does not delay or accelerate the placed-in-service date, because for tax purposes, there is no change in the user of the property—the owner is both landlord and tenant.
- Example: If the building is completed and ready for occupancy on January 1, but the disregarded entity tenant (owned by the same individual) does not move in until March 1, the placed-in-service date is January 1, provided the property was available for its intended use as a rental property as of that date.
b. No Related-Party Lease Issue
Because both the SMLLC and the tenant are disregarded entities owned by the same individual, there is no related-party lease for federal tax purposes. The property is considered used by the owner, and the owner is entitled to begin depreciation when the property is ready and available for use, not when it is actually leased to a third party.
c. Depreciation Method and Recovery Period
- Commercial real property is depreciated under MACRS using the straight-line method over a 39-year recovery period (for nonresidential real property).
- The owner (the individual) claims depreciation on their tax return, as the SMLLC is disregarded.
4. Supporting Authority
- IRS Publication 946: “You begin to depreciate your property when you place it in service for use in your trade or business or for the production of income. You stop depreciating property either when you have fully recovered your cost or other basis or when you retire it from service, whichever happens first.”
- Special Reports, "When Is Property Placed in Service?": The placed-in-service date is the earlier of when the property is ready and available for its intended use or when it is actually used for that purpose. For rental property, this is typically when the property is available for rent, not when it is actually rented.
5. Practical Considerations
- Documentation: The owner should maintain records showing when the property was ready and available for its intended use (e.g., certificate of occupancy, completion of construction, marketing for rent).
- Idle Property: If the property is ready and available but not actually rented, depreciation still begins as of the placed-in-service date, provided the property is held for use in a trade or business or for the production of income.
Summary
For a commercial property owned by a single member LLC, where the tenant is another disregarded entity owned by the same individual, the placed-in-service date for depreciation purposes is when the property is ready and available for its intended use as rental property. The lease to a disregarded entity does not affect this date, as both entities are treated as the same taxpayer. Depreciation begins as of the placed-in-service date, regardless of whether the property is actually rented to a third party, and the owner claims depreciation using the applicable MACRS rules for commercial real property.
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