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IRS Rules Rental Equipment Company Wrongly Claimed Depreciation on Equipment That Was Sold Before It Was Ever Rented

Equipment or Inventory?

The IRS Chief Counsel has determined that a corporate taxpayer may not depreciate equipment primarily held for sale or use that equipment in a tax deferred like-kind exchange. The taxpayer claimed he rents, sells, services, and finances certain equipment. The taxpayer claimed depreciation on equipment held for rent, but was selling the equipment before it was rented. Equipment held for rent may also be sold and when it is, the taxpayer structures the sale as a like-kind exchange.

The Chief Counsel concluded that the equipment should be treated as inventory held primarily for sale to customers.  Inventory held for sale is not eligible for depreciation or a tax deferred like-kind exchange.  The Chief Counsel held that the taxpayer failed to show the primary use of the equipment was not as inventory. A significant factor was that substantial amount of equipment listed as rental equipment was sold to customers before any rental revenue was earned from the property.

Editor’s Comment

The Chief Counsel’s advisory does not appear to affect a company that has legitimate rental equipment. A company that has equipment held primarily for rent will still be able to capitalize the equipment and claim depreciation as an expense. Only equipment held clearly as inventory carries the restrictions noted above.

By: Basi & Basi at the Center for Financial, Legal and Tax Planning for Transworld M&A Advisors