The IRS has published temporary regulations on the tax treatment of tangible property. These regulations are effective now, and they may create valuable tax saving opportunities for property owners.
What they cover
The new rules provide guidance on amounts paid to acquire, produce, or improve tangible property. The IRS states that they cover the accounting for, and dispositions of, property subject to depreciation. The published regulations are 68 pages long, covering many topics.
Among those topics, the regulations illustrate when taxpayers can immediately deduct outlays for property repairs. Such costs usually are considered deductible repair expenses if they do not materially add to the value or to the useful life of property. Conversely, activities that increase or restore a property’s value, substantially add to its useful life, or adapt it to a different use are considered improvements. The money spent on improvements must be capitalized and depreciated over a period of years.
Under the new regulations, repairs made during a time when a property is being renovated or rehabilitated may be deducted if they were not incurred because of the improvement. The costs of routine maintenance on property that is not a building or structural component are generally deductible.
The regulations define routine maintenance as a recurring activity that a taxpayer expects to perform to keep property in its ordinarily efficient operating condition. Examples include inspection, cleaning and testing of an item of equipment, and replacement of parts of the equipment with comparable replacement parts
The regulations also may provide tax relief to property owners who remove a component of a building and replace it. An owner in this situation is not required to capitalize and depreciate the amount paid for the old part while also capitalizing and depreciating the amount paid for the new one. The retirement of a structural component of a building can be considered a separate disposition; the new regulations allow the property owner to recognize a loss on the disposition of a structural building component before the disposition of the entire building. Therefore, the owner will not have to keep depreciating building components that are no longer in service.
Under these new rules, property owners may want to commission certain studies to see if any substantial tax savings can be realized under the new rules. For instance, a property owner might benefit from a building component study that documents the original cost of building components or systems that the owner has replaced.
Example 1: Mary Palmer owns an apartment building. She spends $225,000 to replace the entire roof of the building. Under the new regulations, Mary must capitalize the cost of the new roof and recover her expense via depreciation.
Mary hires a qualified party to perform a building component study, which concludes that the old roof had a cost of $150,000. The new regulations permit Mary to deduct the adjusted depreciable basis of the old roof. If that adjusted depreciable basis is $112,500, Mary is entitled to a $112,500 tax deduction in the year the new roof is installed. Mary won’t have to keep depreciating the old roof and deducting a few thousand dollars each year.
Looking at leases
A lease abandonment study also might be worthwhile. Such a study could document the costs necessary to prepare a property for a new tenant.
Example 2: Nick Raymond purchased a fully occupied building a few years ago. In 2012, one tenant vacates a leased space. Nick decides that he needs to remove and replace some of the components put in place for the former tenant in order to attract a new tenant. The replacement items include walls, electrical wiring, plumbing lines, and ceiling tiles.Nick commissions a lease abandonment study and determines the replaced items cost $60,000. Under the new regulations, Nick can deduct the adjusted basis of the replaced items, which might come out to be about $51,000, in 2012. Again, this upfront deduction is more valuable than extended depreciation.If you are a property owner and you plan on replacing a structural component or renovating a tenant’s space, contact our office to see if the temporary regulations can help deliver sizable tax savings.