Aside from being out of compliance, real estate firms that don’t address the IRS’s new tangible property regulations before they file their 2014 tax return might miss out on a significant tax savings opportunity: This tax year, 2014, is the last year to claim a loss on partial dispositions that occurred before 2014 (that is, for tax years before the effective date of the final tangible property regulations).
The partial disposition election is considered one of the more (if not most) favorable provisions in the final regulations. Real estate firms in particular that don’t take advantage of the opportunity to claim partial disposition losses could be forfeiting significant tax savings depending on the scope of their business and holdings. For example, a firm that spent $500,000 to improve a building in 2008, assuming the original building was placed into service in 2006, might uncover up to $400,000 in losses—reducing its tax liability by $158,000 (assuming a 39.6 percent tax rate).
For partial dispositions occurring in 2014 or later, you’ll be able to take advantage of the provision by making an election on your tax return for any partial dispositions that occurred during the year. But it’s only in 2014 that you’ll be able to make a retroactive partial disposition election for years before 2014 through an automatic accounting method change. The retroactive election must be filed with your 2014 tax return, so it’s imperative you analyze your losses now if you hope to take advantage of them.
It’s worth nothing that those firms that haven’t already analyzed how the final tangible property rules affect their business and implemented any changes necessary to comply before filing their 2014 tax returns will not only miss out on the opportunity—they’ll also be out of compliance.
Given that this tax savings opportunity is primarily available in connection with a capitalized improvement, building improvements—which have a very long recovery period—are of critical interest when you’re identifying losses you can claim under the retroactive election. You’ll want to look back several years to identify opportunities to make a retroactive partial disposition election on an original asset that underwent a capitalized improvement.
How far back you look depends on the amount of the potential partial disposition and how old the original asset is. The older the asset, the more likely it has already been substantially recovered through depreciation deductions. However, some cases may warrant looking at improvements that were made to assets placed in service within the past 20 years—maybe even longer if the potential partial disposition amount is significant.
To start, real estate businesses should review their fixed asset ledger to look for significant capitalized improvements and identify the original asset to which the improvement relates. Then, working with their CPA, they should then determine what work was performed as part of the improvement and what modifications were made to the original asset such that basis could be allocated to any portions removed from the original asset.
Given the time-sensitive nature of this opportunity, real estate businesses should evaluate how the retroactive partial disposition election could benefit them as soon as possible. And because you may incur additional costs to comply with the rest of the final tangible property regulations, the benefit you’re able to derive from this retroactive election could help make up the difference.
Jason Thompson, CPA, provides federal and state taxation services to a variety of individual and business clients with particular emphasis on clients who own, operate, invest, and manage all types of real estate assets. You can reach him at (425) 317-3051 or email@example.com.
Glenn Wattum, CPA, has been in public accounting since 1991. He provides taxation and financial accounting services to companies in construction, engineering, and real estate. You can reach him at (425) 303-3022 or firstname.lastname@example.org.
The opinions expressed here are their own.