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10 Ways the IRS Wants to Help
1. Repair vs Capitalization
- With the Introduction of the Tangible Property Regulations in 2013 – 2014, the IRS came up with several taxpayer friendly approaches to writing off as a Repair item that CPAs may have capitalized in the past.
- Description: The 2013-2014 Tangible Property Regulations allow more items to be written off as repairs rather than capitalize
- Example:
- Replacement of a Roof’s membrane
- Replacement of 30% of a building’s HVAC system
- Refreshing Space is a Repair
- Tax Law Reference:
- Reg. 1.263(a)-3(j)(3) – Example 13
- Reg. 1.263(a)-3(k)(7) – Example 18
- Reg. 1.263(a)
- Additional Food for Thought:
- To apply these laws, you must know your Unit of Property, and the ARB Tests:
- Adaptation
- Restoration
- Betterment
- To apply these laws, you must know your Unit of Property, and the ARB Tests:
2. Partial Asset Disposition (PAD)
- The Tangible Property Regulations give guidance on how taxpayers can write off the partial disposition of their building (PAD) that can occur during a renovation.
- Description: The regulations guide how to write off partial asset dispositions (PAD) during building renovations.
- Example:
- Regs give guidance on how to determine the amount of the deduction – including using the PPI method, specific identification, or a Cost Segregation Study to determine the disposed items.
- Tax Law Reference:
- Reg. 1.168(i)-8(d)
- Additional Food for Thought:
- A PAD can only be deducted in the year the removal takes place. You cannot amend a tax return or file a Form 3115 to adjust for a missed deduction.
3. When a Demolition is not a Demolition
- In general, if a large portion of a building is demolished, the remaining building cost basis, along with the demolition costs, must be capitalized to Land. However, Rev. Proc. 95-27 provides a safe harbor on what is NOT considered a demolition.
- Description: When a significant portion of a building is demolished, related costs must be capitalized, but Rev. Proc. 95-27 offers exceptions.
- Example
- If 75% or more of the existing external walls, AND 75% of the internal structural framework is retained, then you can write off the costs instead of capitalizing the costs to land.
- Tax Law Reference:
- Sec. 280B
- Rev. Proc. 95-27
- Additional Food for Thought:
- Remember this is a Safe Harbor, you are not “limited” to the 75% measurement.
4. General Asset Account Election (GAA)
- If the plan is to demolish a purchased building, AND the building is placed in service, AND you make the GAA election in the year of purchase. Then the taxpayer is allowed to continue to depreciate the building as if it still exists.
- Description: If a building set for demolition is placed in service with a GAA election, it can continue to be depreciated.
- Example:
- Taxpayer buys a property with plans to demolish the building in the future so they can build on the property.
- Tax Law Reference:
- Form 4562 – Line 18 instructions
- Additional Food for Thought:
- Election must be made in the year of purchase
- Election cannot be made for a building purchased and disposed of in the same year
5. 80/20 Rule
- To determine if a building is considered commercial or residential for depreciation purposes, the IRS looks to the rent received during the tax year. If 80% or more of gross rental income is from dwelling units. the property is considered residential. This test is to be measured every year.
- Description: The IRS classifies a building as residential if 80% or more of rental income comes from dwelling units, reviewed annually.
- Example:
- Conversion of a commercial building into apartments. Try to take advantage of the Commercial rules before the property becomes Residential.
- Tax Law Reference:
- Sec. 168(e)(2)(A)(i)
- Additional Food for Thought:
- While Commercial buildings have a longer depreciation life, they have other beneficial tax rules, such as QIP and Sec. 179 on Replacement Roofs and HVAC.
6. Qualified Improvement Property (QIP)
- Improvements made to the Interior of a Commercial Building that:
- Are not an expansion of the building;
- Do not “touch” the outside of the building;
- Not an elevator or escalator;
- Are not part of the structural framework of a building;
- Placed in service AFTER the date the building was placed in service;
- Are QIP.
- QIP assets are depreciated over 15 years and can take advantage of both Bonus Depreciation and Sec. 179 write offs.”
- Description: Qualifying Improvement Property (QIP) includes specific interior improvements, depreciated over 15 years with bonus depreciation and Sec. 179 eligibility.
- Example:
- Many improvements made to preexisting commercial building interiors.
- Hotel Remodeling
- Restaurant Remodeling
- Related Parties can take advantage of this opportunity.
- Tax Law Reference:
- Sec. 168(e)(6)
- Additional Food for Thought:
- Must be commercial property, Residential property does not qualify
- If a Sec. 163(j) Real Estate Election is made, the QIP is depreciated over 20 years, and you cannot take Bonus Depreciation
7. Sec. 179
- 179 has a lot of restrictive rules, but also a lot of tax savings opportunities. Starting in 2018, Commercial Real Estate Owners can write off the cost of Replacement Roofs, HVAC, Sprinkler Systems and QIP.
- Description: Since 2018, Sec. 179 allows deductions for replacement roofs, HVAC, sprinkler systems, and QIP in commercial real estate.
- Example:
- Commercial building owners can write off certain replacement assets, while still taking advantage of the PAD deduction discussed at #2 above.
- Tax Law Reference:
- Sec. 179(e)
- Additional Food for Thought:
- Sec. 179 does have many rules that need to be followed before benefiting from the deduction.
8. De Minimis
- Description:
- The de minimis safe harbor provides an opportunity to expense certain tangible property instead of capitalizing. Unit of Property consideration is key.
- Threshold is $2,500 per invoice and up to double if you have an AFS.
- Detailed invoice review required and allocation of indirect costs essential.
- Short Description: The de minimis safe harbor lets taxpayers expense property under $2,500 per invoice (or higher with an AFS), with specific requirements.
- Example:
- Hotels, Motels, Short-Term Rentals, Bed & Breakfasts
- Assisted living facilities
- Student housing projects
- Entertainment venues
- &More
- Tax Law Reference:
- Sec. 1.263(a)-1(f)
- Additional Food for Thought:
- Made annually by attaching a statement to the taxpayer’s timely filed original federal tax return.
- Expense should occur for the tax year in which the amounts were paid.
- Written accounting procedure requirements.
- Book must = tax.
- Consistency is Key.
9. American Disabilities Act (ADA) Deduction and Tax Credit
- “ADA allows Real Estate Owners to write off up to $15,000 a year for removal of architectural or transportation barriers. In addition, Taxpayers may be able to qualify for an additional $5,000 Federal Tax Credit.”
- Description (Short): ADA allows a $15,000 annual deduction for barrier removal, plus a potential $5,000 federal tax credit.
- Example:
- Adding an Elevator
- sidewalk ramps
- ADA bathrooms
- Tax Law Reference:
- Sec. 190
- Additional Food for Thought:
- These deductions and credits are available for both Residential and Commercial Property
10. Single Economic Unit Election
- It is not unusual for Taxpayers to be their own landlords for their business. To avoid the Passive Activity Rules (which can limit their ability to deduct losses), there is the Passive Activity Single Economic Unit Election. If the Business/Real Estate owner can meet this Election’s rules, the loss generated from the Real Estate entity avoids the passive activity rules and can be used to offset the Business’s income, Easiest approach is to have the rental income/expense be immaterial to the Business operations.
- Description: Business owners who are their own landlords can use the Passive Activity Single Economic Unit Election to offset real estate losses, provided rental activity is minimal.
- Example:
- Business owner who purchases their own to operate their business out of. For example, The Dentist who buys his own building for their practice.
- Tax Law Reference:
- Reg. 1.469-4
- Additional Food for Thought:
- Both the Business and Real Estate entity must be taxed as flow through to individual taxpayers.
- Election is made by the individual taxpayer, not the entity.