Abandonment Study Provides Substantial Cash Flow

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An Abandonment Study is an expanded Cost Segregation Analysis specifically for non-residential income producing properties (leased properties).

• Can provide quicker depreciation deductions.
• Can generate a windfall of depreciation for the owner of investment or owner-occupied real estate.
• Provides the advantage of writing off any “structural” components that are removed when new tenants move in
• Benefits are even greater than those of a Cost Segregation Study.
• The value of disposed “structural” components is generally the highest cost spent in any given suite.
• Owners who are not appropriately writing these off are leaving money on the table and paying excessive tax.
• An Abandonment Study allows you to claim these losses and significantly increase tax savings.

In a typical study, the cost segregation consultant allocates the construction or acquisition costs of a building between long-life building components and shorter-life land improvements and tangible personal property. If the building was acquired or constructed in prior years, the consultant will assist in the preparation of a Form 3115 to change the taxpayer’s accounting methods for these reallocated fixed assets. For many commercial properties, this standard approach does not provide the best benefit for the taxpayer. Cost segregation consultants should consider the many issues related to property improvements that have been demolished or permanently abandoned. The Internal Revenue Service has facilitated this process by continually expanding the automatic consent accounting method change procedures available to taxpayers to resolve this type of issue from prior years. Issues related to abandoned assets typically fall into four areas:

1. Acquired property improvements demolished after the acquisition.
2. Leasehold improvements demolished at the end of the tenant’s lease.
3. Ghost assets disposed of in prior years that remain on the taxpayer’s books.
4. Demolition costs allocated to the improper asset.

 

SourceCorp Professional Service’s multi-disciplinary team of cost segregation professionals can assist you in resolving problems in all of these areas.

Demolished Acquired Property Improvements
Background. Traditionally, demolishing acquired property improvements led to difficult questions of taxpayer intent. If the taxpayer intended to demolish the asset when they acquired it, they could not take a loss on the allocated basis of the asset. With some exceptions, the allocated basis of the asset would be re-allocated to a non-depreciable land account and the taxpayer could not claim a loss on the demolition. On the other hand, if the taxpayer did not intend to demolish the asset when it was acquired, the taxpayer could take a loss on the allocated basis. Naturally, the question of taxpayer intent was frequently litigated.

In the 1980s, Congress simplified the issue by enacting a new law that put the question of taxpayer intent to rest, for buildings at least. Under the new law, taxpayers that acquired buildings and then demolished them must allocate the remaining basis to land and could not claim a loss. The older rule, however, still applies to land improvements and tangible personal property building components. Even though the new rule technically applies only when the old rule did not already apply, in practice demolitions are usually only analyzed under the new rule.

IRS Simplifications. The Internal Revenue Service has simplified the application of the new rule by defining a building demolition to include only demolition projects where less than 75% of the existing external walls remain as internal or external walls and less than 75% of the internal structural framework remains. This permits taxpayers to write off a portion of assets in many acquisitions that are subsequently remodeled.

Demolished Leasehold Improvements
Background. When the Tax Reform Act of 1986 created the Modified Accelerated Cost Recovery System (“MACRS”), the recovery period for many leasehold improvements became 31.5 years (later 39 years). The ban on component depreciation was also widely viewed as prohibiting taxpayers from writing off leasehold improvements disposed of by landlords at the end of the tenant’s lease. In 1996, Congress modified MACRS to permit taxpayer to write off leasehold improvements disposed of at the end of the tenant’s lease.

IRS Simplifications. Under Revenue Procedure 2008-52, the IRS now allows taxpayers to change their method of accounting to recognize a loss on leasehold improvements that remain on their books for depreciation purposes but that were permanently disposed of at the end of a tenant’s lease after June 13, 1996. This new method change applies only to improvements made by the landlord for the tenant. It does not apply in a ground-lease situation where the landlord constructs a building that is later demolished at the end of the tenant’s lease.

Ghost Assets
Background. In addition to demolished leasehold improvements, taxpayers frequently keep assets on their books that have been disposed of. These are called “ghost assets”. When the ghost assets are short-life assets identified in a cost segregation study, taxpayers can still claim the full allowable depreciation in many situations.

IRS Simplifications. If the ghost assets were demolished in the current year or in the year for which the taxpayer is filing a prospective, original tax return, the IRS allows a method change to claim the full allowable depreciation. For example, if a taxpayer demolished assets in 2007, it can claim the full allowable depreciation via a Form 3115 method change application on its 2007 return as long it files the original or superseding return before the extended due date (and also files a copy with the IRS National Office).

Improper Demolition Cost Allocations
Background. When taxpayers demolish and then replace assets, they frequently capitalize the demolition costs as part of the construction costs of the new assets. In 2000, the IRS ruled that the demolition costs should be allocated to the demolished assets and not capitalized as part of the replacement assets.

IRS Simplifications. The IRS permits an automatic method change that allows taxpayers to conform their treatment of demolition costs to the IRS ruling in 2000.

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