If you’re investing capital in the improvement of a building or other real estate, there’s a good chance that the project will involve demolishing and/or removing some of the property. If that’s the case, it’s important to make a “partial disposition election” early in the project to preserve valuable tax benefits. This election is easily overlooked, especially when demolition or removal occurs at or near the beginning of a multi-month or multi-year project. But failure to make the election on a timely basis can lead to the loss of these benefits.
Current tax regulations provide that if you demolish or remove a portion of real property as part of an improvement project, you may 1) claim a loss by making a partial disposition election (generally, this means writing off the remaining adjusted basis of the demolished or removed portion of the property), and 2) deduct, rather than capitalize, the removal costs (which, in many cases, are substantially greater than the loss). To enjoy these benefits, you must make a partial disposition election by claiming the loss on your tax return for the year in which the disposition occurs and deduct the removal costs on that return. This can be confusing because under previous rules removal costs would not have been deductible. Rather, they were required to be capitalized to the improved property in the year it was placed in service. In other words, there was no reason to worry about the tax treatment of removal costs in the year they were incurred.
Under current rules, however, if you demolish/remove a portion of real property in year one of a project but fail to make a partial disposition election on your return for that year, you’ll lose the ability to claim a partial disposition loss and deduct the removal costs. If you miss this opportunity, it may be possible to apply to the IRS for permission to file a late election, but this process is fraught with uncertainty and can be expensive.
If you’re embarking on a real property improvement project, please contact us. We can help you ensure that you receive all the tax benefits to which you’re entitled.