New Final Regulations for Real Estate Tax Deductions
1/16/2014 2:07 PM
Owners of commercial real estate and property managers have long recognized the benefit of the depreciation deduction. Owners will frequently hire an engineering firm to conduct a cost segregation study on acquired property to identify and quantify assets with shorter depreciable lives. These cost segregation studies help maximize the benefit of the depreciation deduction available to the owner. However, there are significant costs and effort required to complete this work, and the practice has attracted increased scrutiny from the Internal Revenue Service (IRS).
During 2013, the IRS released final repair and capitalization regulations giving additional guidance to commercial real estate owners and managers over what taxpayers are allowed to deduct when acquiring, repairing or replacing tangible property. The goal behind the new final regulations is to remove the subjective nature of the existing standards and add some safe harbors protections and simplify the standards. Commercial real estate owners and managers need to be aware of the new tax deduction opportunities and challenges the new regulations will present.
Some items to note for commercial real estate owners and managers include the following:
- There is a safe harbor provided for routine maintenance that will allow for the expensing of the costs for a building’s “routine maintenance” activities and its repairs to the structural components and building systems. To meet the standard, an activity is covered only if the taxpayer reasonably expects to perform the repairs more than once over a 10 year period.
- If a taxpayer has a written policy and receives audited financial statements from a Certified Public Accountant, they may establish a safe harbor of $5,000 or less per invoice to expense materials and supplies that have a useful life of less than 12 months. Even without audited financial statements a safe harbor of $500 per invoice can still be adopted.
- Taxpayers are still required to capitalize amounts paid to improve a unit of property. A “unit of property” for this purpose consists of a group of functionally interdependent components (a building). However, certain major systems of the building, such as HVAC, plumbing and electrical are all treated as separate units of property for purposes of determining whether or not a betterment, restoration or adaptation of the property has occurred. A unit of property is considered improved if amounts paid by the taxpayer result in a betterment of the unit of property, a restoration of the unit of property or an adaptation of the unit of property to a new or different use.
The final regulations are more taxpayer friendly than the temporary regulations of the past few years, but at over 200 pages, still require a significant investment in time and talent to assure compliance. As fixed assets are the single largest asset on the balance sheet of a real estate investment, every real estate owner and property manager should be aware of these regulations in order to maximize the potential benefits.
Be sure to consult with your tax professional to properly establish the written policies necessary to ensure compliance with the final regulations.