Since the IRS released the final property repair regulations, many commercial real estate and other businesses have been seeking to take advantage of key tax saving opportunities.
See also Real Estate
Specifically, a key feature of the final regulations is that a taxpayer can claim an immediate loss on an asset disposition. Formally known as a “partial asset disposition election,” a taxpayer can claim an immediate loss, which results in a current year tax savings. The disposition election permits the taxpayer to recognize the loss on the disposition of a structural component of a building or a portion of a structural component (for example, a building’s roof). It also permits the recognition of a loss on the disposition of a component of any other asset type. To help clients, prospects and others understand the election, Hanson & Co. has provided a brief summary below.
Partial Disposition Election Summary
As part of the new final property repair regulations, the IRS now permits commercial real estate owners to make a partial disposition election. This means that a commercial property owner can make an annual disposition election for qualifying changes or improvements (i.e. replacing the roof to the building, replacing windows, or upgrading the HVAC unit). This is important because it allows the taxpayer to identify a portion of the asset (roof, windows, HVAC unit) even though the building is the asset for depreciation purposes. In the case of a roof replacement, the election permits taxpayers to claim a loss on the disposed portion of the roof rather than depreciating both the old and new roof on the company’s books. What makes the election more attractive for taxpayers is that they can recognize the loss in the tax year it was incurred. This is in stark contrast to the prior regulations, which required the asset to be depreciated over the standard 39-year timeline. The bottom line is that the tax benefit is realized almost immediately.
Disposition Election Example
To take these accounting concepts and make them easier to understand, an example is often useful. Assume a taxpayer owns a retail building and wants to convert a portion of it for warehouse use. The owner constructed the building in 2010 for $1M USD. To make the conversion for the new use, the owner has to remove part of the front exterior wall and install new doors to accommodate trucks and other commercial vehicles. The cost of the wall in 2010 was $60,000 and was set up to depreciate according to the traditional 39-year formula. Assuming the cost of the new doors is capitalized as an improvement, the taxpayer may now make a partial asset disposition election for the original wall. This election would allow them to write off tens of thousands of dollars of the remaining basis.
The good news is that the election is not available only to building owners; landlords that renovate space for a tenant are also eligible to make the election. To the extent that portions of leased space are renovated, removed or otherwise significantly changed, the landlord can write off the remaining basis of the disposed assets. This is much more favorable than prior regulations which allowed the landlord to take a loss once a lease was terminated, but not before. Again, the immediate tax savings is quite attractive for many.
In most cases a partial asset disposition is elective, but the IRS has deemed that under certain circumstances it can be mandatory. This includes disposition from a casualty event, such as a hurricane, tornado, fire or other such event. It is also required in the case of a like-kind exchange and when a portion of an asset is transferred or sold.
The partial asset disposition election is a powerful tax savings tool for qualifying property owners and landlords. While it may seem somewhat complex, it’s important to understand the benefit it can offer to your tax situation. If you have questions about the election or are curious about the potential benefit, Hanson & Co wants to help. For additional information, please call us at (303) 388-1010, or click here to contact us. We look forward to speaking with you soon.