Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 79-40

1979-1 C.B. 13

Section 46
Section 167

IRS Headnote

Depreciation and investment credit; placed in service; machinery and equipment. Machinery and equipment are placed in service for depreciation and investment credit purposes in the year critical tests with appropriate materials and operational testing are completed and they are determined to be operational, even though completely installed and partially tested with substitute materials in a prior year.

Full Text

Rev. Rul. 79-40

ISSUE

When are machinery and equipment acquired and installed in a production facility placed in service for depreciation and investment tax credit purposes, under the circumstances described below.

FACTS

In November 1977, the taxpayer installed machinery and equipment in an existing building for use in its manufacturing business. The machinery and equipment, while completely installed and partially tested with substitute materials, had not had any critical tests performed with appropriate materials until early 1978 when such tests and adjustments were completed. Operating tests to eliminate defects that may affect optimum production capacity may still be required. The taxpayer plans to use the machinery and equipment in its production process. The building and installed machinery and equipment are in the control of the taxpayer with all legal attributes of ownership such as title, risk of loss, and liability. The machinery and equipment are depreciable and the taxpayer has elected the Class Life Asset Depreciation Range (CLADR) system for its machinery and equipment. The machinery and equipment have a useful life in excess of 3 years.

LAW AND ANALYSIS

Section 38 of the Internal Revenue Code of 1954 allows a credit against federal income tax for qualified investment in "section 38 property."

Section 1.46-3(d)(1)(ii) of the Income Tax Regulations provides, for purposes of the investment tax credit, that property is placed in service in the taxable year in which it is placed in a condition or state of readiness and availability for a specifically assigned function, whether in a trade or business, or in the production of income.

Section 1.46-3(d)(2)(iii) of the regulations provides that equipment is considered in a condition or state of readiness and availability for a specifically assigned function if it is acquired for a specifically assigned function and is operational but undergoing testing to eliminate any defects.

Section 167 of the Code provides that a reasonable allowance for the exhaustion, wear and tear, and obsolescence of property used in a trade or business or held for the production of income shall be allowed as a depreciation deduction.

Section 1.167(a)-11(e)(1)(i) of the regulations provides that 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, or in the production of income. In general, the provisions of section 1.46-3(d)(1)(ii) and (d)(2) shall apply for the purpose of determining the date on which the property is placed in service.

To meet the requirements of section 1.46-3(d)(2)(iii) and 1.167(a)-11(e)(1)(i) of the regulations, machinery and equipment must first be operational. Under the facts in this case, the machinery and equipment were not operational until early 1978, when the critical tests with the appropriate materials and operational testing were completed. It was then determined that the entire system was able to perform the function for which it was designed, even though some testing to eliminate defects that affect its optimum production capacity may have to be performed subsequently.

HOLDING

The machinery and equipment were placed in service for depreciation and investment credit purposes in 1978.