CREJ - Property Management Quarterly - May 2015
The Internal Revenue Service recently issued the final Tangible Property Regulations, which clarify when building owners need to capitalize expenditures as improvements and when they can immediately deduct them as repair expenses. For real estate owners who understand these new rules, the TPRs are mostly favorable and allow many to claim millions of dollars in previously missed deductions. However, the TPRs require additional effort to be in compliance and to optimize their effect. The TPRs are all encompassing and complex, and implementation requires careful consideration of each property owner’s facts and circumstances. Numerous real estate owners as well as tax professionals have struggled with compliance aspects under the TPRs. In addition, property owners may need to devise new accounting procedures to capture the necessary data to implement these regulations. Below is a summary of key facets of the new tax law. Partial dispositions. Prior to the TPRs, the IRS’s position was that owners cannot deduct the tax basis of building components, such as roofs, heating, ventilating and airconditioning equipment or windows that have since been removed. The new rules allow owners to take losses on the undepreciated basis of these components, which can be very valuable. For the 2014 tax year only, the IRS allows a simplified approach to write-off disposed building components that were removed prior to 2014. This window of opportunity is closed after Sept. 15 (the extended due date of most 2014 returns). Review past expenditures. The new regulations allow owners to review their fixed assets for capitalized expenditures that are more akin to maintenance and repair expenses and immediately deduct them. Replacing roofs and HVAC units often are capitalized but can be written off immediately, yielding significant tax savings. Conversely, owners who were overly aggressive in immediately deducting capital expenditures should review prior year repairs registers as well as their current year capitalization policies. Demolition costs. Under prior law, owners were required to capitalize removal costs into the basis of the new asset. Now owners immediately can deduct component removal costs. This does not apply to demolition of an entire building. Owners should request that contractors state removal costs separately on invoices, and then immediately deduct such expenditures. Cost segregations have increased relevance. Cost segregation studies have traditionally focused on accelerating the timing of deductions by carving out personal property and land improvements, which have favorable tax attributes, from building costs, which have poor tax attributes. Under the TPRs, cost segregations have increased utility in quantifying the costs of removed components, such as an old roof or HVAC components, since taxpayers are allowed to take losses on them.
Those who manage real estate portfolios should be reviewing these regulations with a tax professional as well as reviewing past expenditures to identify opportunities or exposure items and current policies to ensure compliance. For property owners, managing this effort may require assistance from a third-party team that can efficiently handle the process of gathering, analyzing, documenting and securing any missed deductions. There is no easy, one-size-fits all way to analyze these rules and applying them takes careful planning and implementation to assure compliance with the regulations. Consulting with a knowledgeable tax professional in advance of incurring major repair, maintenance or replacement costs is strongly recommended.