Cost Seg Building

A Blog About Tax Savings for Building Owners

Tag: PAD

Unlocking Tax Savings: How Commercial Property Owners Can Benefit from Partial Asset Disposition During Renovations

May 8, 2024 /


Partial Asset Disposition (PAD) is a tax strategy that can be highly beneficial for commercial property owners, especially during renovations or upgrades. Essentially, PAD allows property owners to decrease their taxable income by writing down the depreciable basis of certain assets that are removed and disposed of during property renovations.

When a commercial property undergoes renovations, certain existing assets may need to be removed—anything from lighting fixtures and HVAC units to doors, windows, and even structural elements like roofing. Under PAD, the cost of these removed items, including the expenses associated with their removal and disposal, can be written down. This write-down provides an immediate tax deduction for the property owner in the year the renovation occurs. It’s crucial to note that this is a time-sensitive opportunity: if the write-down is not applied in the tax year during which the renovation happens, the chance for that deduction is permanently lost. It’s a use it or lose it tax deduction.

The benefits of implementing PAD extend beyond immediate tax relief. At the time of sale of the property, PAD can lead to permanent tax savings by reducing the overall basis of the building, thereby decreasing recapture tax on property that is no longer part of the property.

This strategy is particularly relevant for a range of commercial property owners, including:

  • Retail lessors who might acquire assets left behind by tenants.
  • Property owners undertaking significant renovations, repairs, or improvements in areas such as roofing, lighting, parking lot resurfacing, door and window replacement, floor resurfacing, and both interior and exterior painting, where costs exceed $50,000.
  • Owners who have demolished parts of a facility as part of an improvement or renovation project with costs over $50,000.
  • Those who have acquired, constructed, or expanded facilities since 2000.
  • Businesses that have recently upgraded or replaced major operational equipment within the tax year.
  • Pass-through entities that may be considering a sale soon, especially if there has been significant appreciation in the value of their facilities or operational assets.

The IRS’s final tangible property regulations under Section 263(a) offer comprehensive guidelines on how these assets should be handled for tax purposes. Tax professionals are encouraged to guide their clients in making an annual election to claim these deductions, ensuring that they do not miss out on substantial tax benefits.

To accurately assess and claim these deductions, conducting an engineering-based cost study is advisable. This approach provides tax professionals with precise, defendable calculations that can be directly applied to a client’s tax returns, maximizing the potential benefits of PAD. This detailed evaluation not only supports the claim but also ensures compliance with tax laws, making the deduction process smooth and justified. As always, be sure to consult with your own tax advisor.

Understanding the Impact of Tangible Property Regulations on Landlords and Tenants: Capitalization vs. Expense Deduction for Tenant Improvements

March 13, 2023 /
Tenant Improvements – Photo Credit John Murphy, Cost Seg Building

Are you looking to do tenant improvments (TIs) to your building? Are you aware that the Tangible Property Regulations (TPRs), i.e. repair regulations, are to your benefit as a building owner? There are specific guidelines to help building owners save money on their taxes when it comes to TIs. Many times we see that owners have capitalized items that could have been expensed. Not only is that the incorrect way to account for some items, the IRS doesn’t want you to do it that way and it’s costing you quite a bit in lost tax savings.

The words lessee and lessor in §1.162 and §1.263(a) (Tangible Property Regulations) are mentioned over 200 times. The TPRs are a dramatic change for landlord and tenants regarding the capitalization or expense deduction of tenant improvements.

There are two critical general rules under §1.263(a) for leased property and improvements.

The first general rule is that an improvement to a unit of property is NOT a separate unit of property from the building. The second general rule is if the landlord’s expenditure is NOT a restoration, adaptation, betterment, or improvement (RABI), then it is repair and maintenance.
The unit of property for a taxpayer who is the lessee of an entire building is each separate building, its structural components, and building systems.

If the lessee leases only a portion of a building (such as an office, entire floor, or specified square footage), the portion of each building and the building systems associated with ONLY the leased portion is the unit of property. If the lessee pays for the tenant improvements, the lessee must generally capitalize the related amounts, which it pays to improve the tenant space. The only exception is if §110 applies. §110 is a construction allowance received by the lessee for the sole purpose of the improvement or when the improvement constitutes a substitute for rent.

In other words, tenants who do not lease the entire building and pay for their tenant improvements have their separate unit of property, and those improvements must be capitalized under the UNICAP rules §263A.

If the landlord pays for the tenant improvements, they must be put through the RABI rules (restoration, adaptation, betterment or improvement) to determine if the tenant improvements are a repair and maintenance item or if they must be capitalized. Generally, an amount capitalized as a tenant improvement is not a separate unit of property from the building. If the landlord’s tenant improvements are not a separate unit of property from the building, the landlord can compare the expenditure against the whole building, building structures, and building systems. The result will be that most landlord tenant improvements, (beyond the initial tenant improvements capitalized for each space), will be classified as a repair and maintenance expense.

Example

The landlord owns and operates two buildings. One is a 4-story office building of 40,000 square feet with the first floor consisting of retail space. The other building is a stand-alone 10,000-square-foot retail building. The landlord has two new tenants move in 2022. Tenant A leases the first floor of the 4-story building. Tenant B leases the stand-alone building. The landlord already had prior tenants in those spaces and has tenant improvements on its books for both of those building spaces. The landlord tears out the previous tenant improvements and does extensive new tenant improvements for both tenants.

Conclusion

The landlord can expense the tenant improvements for Tenant A in the office building but must capitalize the tenant improvements for Tenant B. The reason he can expense the TIs for the office building is that the space being renovated consists of only 25% of the building. The Tangible Property Regulations allow that if you are improving less than 30-35% of the building that those costs might be able to be expensed instead of capitalized. However, we will often see that owners have indeed capitalized such items.

Regarding Tenant B, the landlord must capitalize those improvements because because it’s 100% of the property. However, they can do a partial asset disposition (PAD) and get a significant tax deduction for the removal of those previous tenant improvements that had been in the building. PADs must be completed in the tax year in which the work (improvement / renovation) was done.

So what’s the difference between these two buildings? The landlord replaced a large physical portion of the stand-alone building that B occupied but only improved 25% of the building that tenant A was to occupy.

If you are a building owner and you are doing tenant improvements, reach out to consult with me at no charge. We can discuss your situation and see if it makes sense to expense or capitalize your improvements and whether or not it might qualify for a partial asset disposition.

The original article appeared on CSSI’s website and has been updated here at Cost Seg Building.

Chick-Fil-A Woodlawn Road Charlotte Proposes 3 Lane Wide Drive-thru to Help Traffic Back Up – Partial Asset Disposition Opportunity

January 17, 2023 /
Image: Google Street View of 1540 E Woodlawn Road, Charlotte, NC – Chick-Fil-A Restaurant

It’s a common issue many of us have seen whereever there is a Chick-Fil-A…cars backed up into the main roadway as they wait in line to place their order for food. Chick-Fil-A has really mastered the art of the drive-thru and during and after Covid, they were the first that I saw that doubled up their drive-thrus expanding capacity. McDonalds had kind of done that over the past few years but CFA had taken it to an entire new level.

Now they are looking at going 3 wide instead of 2 wide in their drive-thru lanes. This is an attempt to deal with the complaints of traffic being backed up along Woodlawn Road in Charlotte during meal time. Chick-Fil-A is proposing that they go full on drive-thru only operation and eliminate dining to only have room for 3 drive-thru lanes and keep more traffic on their property rather than spilling out onto Woodlawn. According to the article in Axios Charlotte, this has caused a conundrum for city planners and council because they want a community that is more walkable and less dependent upon the automobile. In this case, in order to possibly improve the situation of the traffic congestion, it only ends up making the business more dependent upon the automobile. That said though, I think the public has spoken regarding Chick-Fil-A and in most cases, people just can’t get enough of it and because CFA does such an awesome job with their service via the drive-thru that people continue to frequent their stores and opt to get their food that way.

Since this blog is about cost segregation, this project will be an exellent opportunity for partial asset disposition (PAD). Because part of the building will be removed, we would calculate what that value is and what the remaining basis is on the books and get that removed from the books. It’s an immediate tax deduction in the year in which the work was done and then that amount is also removed off the depreciation schedule for the building so the owner doesn’t have to worry about paying recapture tax on that property that is no longer part of the building. It’s kind of a double tax savings but it’s a use it or lose it tax benefit. A partial asset disposition must be taken in the tax year in which the work was done. If you don’t file it in that same tax year, you cannot amend your tax returns to claim the deduction.

The company that appears to own this Chick-Fil-A at 1540 E Woodlawn Road, Charlotte, NC looks to be Charter Venture LLC. I don’t know if they are considering doing a PAD or not.

Building Owners – Did You Do a Signifant Renovation in 2022?

December 12, 2022 /

Just a reminder for building owners and their tax professionals out there…we are the outsourced provider for hundreds of tax professionals and firms who need to get cost segregation done for their clients. We can help with partial asset dispositions on large ($100k+) renovations as well as capitalization to expense reversals. If you have clients who have buildings and if they haven’t done a cost seg study, reach out and let’s talk. We can usually make it work for a client down to about $200,000 in depreciable building cost / basis. We are still 5-6 weeks away from our deadlines to hit tax deadlines of 3/15 and 4/18/23…that time will go fast. Let’s get them scheduled.

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