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Articles
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Practical Applications for CSS - Redevelopment Projects
Publication:
New York Real Estate Journal (May, 2006)
Authors:
Greg K. Bryant
Jacob D. Hopper
While cost segregation studies
(CSS) are routinely performed after
acquisition or new construction, the
additional benefits of these studies
are too often overlooked in the case
of redevelopment, renovation of
existing structures or abandonment
of previously occupied lease space.
However, since the IRS will not
allow a taxpayer to write off arbitrary
amounts based on cost per s/f,
or other internally developed methods,
it is important that a CSS be
performed to maximize tax benefits.
Careful consideration should be
given when using a CSS with a redevelopment
project as the timing is
critical. A poorly timed study can
result in significant lost opportunities.
Important distinctions also exist
with respect to the actual definitions
of “demolition” vs. “renovation.”
With current market trends towards
redevelopment, real estate developers
now have the option of turning
to their cost segregation consultants
much earlier in order to maximize
their depreciation deductions.
Remodel vs. Demolition - What a Difference a Word Makes
Current tax code (sect. 280B) does
not allow an owner to deduct expenses
for demolition of a building
or any loss sustained due to the demolition.
However, a renovation can be
subject to a different set of parameters.
If one is weighing the option to
renovate rather than demolish a property,
it is important to know the details;
renovation is not considered
demolition if:
1.) 75% of the external walls are retained.
2.) 75% of the existing internal structural framework of the building is retained.
If both requirements are met, then
all expenses are deductible as a renovation.
If not, the basis of the demolished
structure and any demolition
costs are added to land, which are
not depreciable.
In addition to identifying costs
that can be allocated to shorter recovery
periods a CSS can be used to
help determine the project scope with
respect to how much of the existing
facility is going to be demolished.
Demolition
If your project does not comply
with the above criteria, and is considered
a total demolition, hope of
a deduction is not entirely lost.
Regulation sect. 1.48-1 defines the
structure as a building and its structural
components. However, the
tangible personal property within
the structure (or a part of it) can be
written off when the building is
demolished, provided (1) the personal
property is to be abandoned,
(2) it was not purchased with the
intent to demolish, and (3) it is
identified and valued prior to demolition.
Determining the value of
personal property through a cost
segregation study is the only acceptable
way to satisfy the IRS.
Redevelopment
The most important thing to remember
in a redevelopment scenario
is that a CSS should be done
immediately following acquisition.
Continued involvement of the CSS
consultant during the design and
redevelopment stage will ensure
that capitalization of expensed costs
is properly documented. If the 75%
demolition rules are met, then the
cost of improvements removed
would likely be expensed in one
year. Soft costs such as architectural
and engineering fees as well
as construction period interest can also be captured as allocated costs
and are subject to the ultimate percentage
allocations of 39, 15, 7 and
5-year recovery periods for the completed
project.
Abandonment of Tenant Improvements
Tenant improvement expenses
can be significant, especially in
larger facilities. When a tenant vacates,
the leased premises is often
gutted and refitted for a new occupant.
So, what about the improvements
that were abandoned? If a
CSS had been performed prior to the
renovation, the owner would have a
defensible position to write off the
remaining depreciable basis for all
improvements taken out of service.
These studies, typically known as
abandonment studies can be part of
a CSS. The completion of detailed
tenant studies for ultimate abandonment
calculations has become
an important strategy; especially for
developers who are contemplating
acquisition of existing properties
with the intent to reposition or retenant
in the near term.
Due to complexity of these issues,
close communication with your
cost segregation consultant and tax
advisor will ensure that depreciation
deductions and demolition expenses
can be maximized. Timing
is important! It is impossible to
place a value on a pile of construction
debris that was once a building
or tenant improvement.
