Partial Asset Dispositions: Providing Value to Items in the Trash
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When a taxpayer disposes of a portion of an asset, in this case, a building, the trash from the old building sections can be expensed. You read that right. Simply put, everything tossed in a dumpster from a renovation has a taxable value and can be expensed.
Expensing the remaining taxable value is called a partial asset disposition (PAD) and is detailed in IRS § 1.168(i)-8 Dispositions of MACRS property. ALMOST EVERY OTHER cost segregation firm, as well as many CPAs, miss PADs because it requires both engineering expertise AND tax knowledge.
Here is an example to provide clarification:
For three years, Mr. Smith has owned an office building that has two elevator banks. In the third year of ownership, Mr. Smith replaces one of the elevators for $500,000. Under the Tangible Property Regulations (§263a), the new elevator must be depreciated (see Note 1 below).
But what about the old elevator? Does that continue to be depreciated even though it’s sitting in a landfill or being refurbished for sale to another building owner?
No.
The building is the actual asset, and the disposed-of component is the elevator. When a portion of an asset is disposed of, the disposed of components can be expensed as if they were new, minus any depreciation that was taken. However, an election must be made on Mr. Smith’s tax return to qualify.
Assuming the old elevator also cost $500,000 and was depreciated for three years, it has a remaining depreciable basis of $461,538.
Mr. Smith makes the partial disposition election and takes a one-time expense, which would be a tax deduction of $461,538 in the year the elevator was retired. The depreciation of the old elevator, which is no longer part of the building, stops. The depreciation on the new elevator is taken, and Mr. Smith receives an annual deduction of $12,820.
As a side note, if a partial asset disposition had not occurred, the old elevator is called a ghost asset. Ghost assets are very costly.
Some Important Notes Regarding Partial Asset Dispositions:
- The partial asset disposition is only available if the new elevator is capitalized. If the facts and circumstances are such that the new elevator can be expensed, a partial asset disposition cannot be used. For instance, in the provided example, there are only two elevators. When an expenditure impacts more than 33% of like components, which in this case are the elevators, the expenditure must be depreciated over 39 years. Had there been more elevators in the building, the new elevator could have potentially been expensed.
- The IRS states that any reasonable method can be used to calculate the value of the old escalator. However, a cost segregation study, according to the IRS, is a “certain method” and is one additional way a cost segregation study can be used.
- The partial asset disposition expense MUST be taken in the same tax year the building modules or components were disposed of. If the PAD is missed, it is gone forever.
Don’t YOU miss it. Call Kevin Jerry at 502-216-5941.