Commercial rental razed and replaced

[henryclay]

After buying a store building for rental purposes, half way through the depreciable life the owner said the upkeep was eating too much of the rental income and the tenant, considering the condition of the building, was also unhappy, so he tore it down and built a new structure.

What to do with the remaining depreciable basis of the razed structure?

Some say the cost of demolishing the old building plus the unused remaining depreciation should be added to the basis in the land, and that the construction costs of the new structure should not be part of the computation, , , that it should stand on it's own. My reading of Publication 544 leaves me unclear as to how to handle it.

That seems reasonable to me, but is it correct?

A reliable source reference would be appreciated. . . . along with suggestions about any gaps, of course.

[rangerj]

The demolition costs are added to the land as they are the costs or "preparing the land" for use. This came out of court cases and Revenue Rulings many , many, years ago. The remaining depreciable costs of an asset disposed of usually gets deducted. I do not remember any rulings or pronouncement that would prescribe adding those costs to the land value. The first part of this post is from personal research for a client, albeit eons ago. The later is "shot from the hip", so take it at face value.

[henryclay]

Thanks, rangerj. It's always a pleasure to see your reasoning.

Especially when it so closely mirrors my own.

I can see both sides of the IRS's position. The destruction of the old building was a voluntary act, and one from which the US should not suffer a loss of revenue. The other side is that the removal of the structure and replacing it with a new one lends a greated probability of revenue to the US than continued use of the old one because of it's loss of desireability as a business rental, and the extended write off of greater and greater repair costs against the resulting reduced rental income.

But I wish I could read how similar cases were processed in the (recent) past.

Thanks again.

[rangerj]

Henry, what would you do with a piece of equipment that has not been fully depreciated and has been scrapped with no amount of scrap income. Would you expense the unused depreciable costs? Tax law does not require that the unused capitalized amount be depreciated or amortized over the original depreciable life, does it? If the building were purchased with destruction in mind in order to gain the specific location, that is the land, then the cost would be capitalized as part of the land costs even if the demolition is not done as soon as the purchase is completed. I recall that there is a case where the building was purchased with the "plan" to demolish it and even though the taxpayer operated the building for five years after the purchase the court relied on the "intent" of the buyer to determine that the cost should be capitalized as part of the land costs. Your fact pattern is different.

[commentator]

I know that building removal costs add to land basis when demolishing a building on a newly acquired piece of land.

However, in the situation described in the OP, the building as been in use by the taxpayer for a number of years. I'd like to have a citation (or two) showing that demolition in that situation results in unrecovered basis being added to land basis instead of being taken as an immediate loss.

[rangerj]

Just for you Henry, Currahee. See Revenue Ruling 2000-7, 2000-1 CB 712 Feb. 8, 2000. There are numerous cross references in this ruling attesting to the age of the "issue". You will see the court case I mentioned cited in this more recent ruling. And to think I call my wife of 40 years Honey because I cannot remember her name 1/2 the time!!!

[commentator]

Well, Rev Rul 2000-7 (which appears in IRB 2000-9) holds that neither the remaining basis in the old asset nor the cost of removing the old asset is added to the basis of the new asset.

While that tends to support my position, it should be noted that the example in the Rev Rul deals with tangible business use personal property (telephone poles), not with realty. However, Rev Rul 2000-7 is an interpretation of IRC Section 263 which deals with capitalizing the costs of both business use personal property and business use real estate.

Absent IRS pronouncements are court decisions to the contrary, I will continue to argue that the OP's situation allows for the unrecovered basis and demolition/removal costs to be deducted immediately.

[mwcpa]

I agree with commentator.... a few years ago a client who owed a large residential building decided to renovate units as they became available for rent (so he could ask for higher rents), the renovation included a full gut of the apartment. years prior a cost segmentation study was done (so we had the 'cost' of each unit). we were able to "write off" the remaining basis of the individual units when they were demolished.

[henryclay]

Currahee, rangerj Well, Semper Fi, actually. But thanks. Thanks to you all.