Abandonment Loss and Demolition

Written by Steven D. Beaucaire, MST
Vice President, Tax - Bedford Capital Consulting

Only in tax law could the word abandonment sound like a good deal. But taxpayer, beware! If you want a piece of land and it just happens to have a building on it, do not buy it thinking you will recoup a part of the price with deductions for the removal of the building. Too often the appeal of the abandonment deduction in the U.S. Tax Code misleads the purchaser. This tax benefit is wholly dependent upon narrow circumstances that need to be carefully examined, and understanding the particulars of the law can save the investor many headaches.

The first and most important point to consider is that any time property is purchased with the intent to abandon it, no loss is ever allowed.1 The code states, "a taxpayer who abandons property held for use in a trade or business or in a transaction undertaken for profit is entitled to a loss based on the property's adjusted tax basis", but the abandonment regulations were written for the owner who finds it necessary to abandon property because there are no other viable options, and that the abandoned property "will not be used again or be retrieved for sale or for other disposition."2 It must be demonstrated to the IRS that abandoning the property was not the owner’s original intent. And what happens if there is personal property in this building? The same guideline applies: if there was intent to abandon it at the time of purchase, there is no deduction.

The IRS generally takes the view that if abandonment and demolition come soon after the purchase, then that was the intent at the time of the purchase. On the other hand, if the property was purchased and run "as is" for a period, and then a decision was reached to abandon the building for the business to survive, one would be eligible for the deduction on the loss.

Because no standard exists to define how long a period of time has to elapse, the length of the operating period is like a work of art. Just as "beauty is in the eyes of the beholder" in the art world, so too is a reasonable time between the purchase, the abandonment, and then the demolition. That means the burden of proof is thrust back on the taxpayer. So the owner needs to consider the demolition rules (IRC §280B) because if the demolition happens at the time of abandonment, then the demolition rules will cancel out any abandonment loss.

The first step to see if the demolition rules apply is to use the following test. Structural modification will not be considered demolition if:

1. 75% of the external walls are retained in place as external or internal walls; and
2. 75% of the existing internal structural framework of the building is retained in place.3
   

If the answer to either question is no, then the demolition rules of §280B apply. This means that both the cost of demolition and the value of the structure (building and structural components) are capitalized to land and that means no depreciation, ever.4 If the answer is yes to both of the above questions, then the work is considered a renovation. In that case, the savvy business decision is to design renovations to meet the test above and reap the tax depreciation on both the remodeling costs including demolition and the new assets.

As stated above, if personal property was purchased with the intent to abandon it, there is no deduction. However if there was no "intent" and if the demolition rules do not apply, then you are allowed to deduct the remaining basis of the specific items abandoned. Because the assets must be accounted for in sufficient detail to identify them properly, documentation is vital. Normally the purchase and sale document does not go into this kind of detail, so in either situation having a cost segregation study done by a qualified engineer can make or break your case.

For the knowledgeable businessperson, a "good deal" is still within one's grasp. The key is to know when and how to manage property investments in order to maximize tax benefits. Good timing and thorough documentation via a cost segregation study can make the difference.