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April 22, 2014

Over the last two years, the new temporary and proposed reliance tangible property capitalization regulations have brought to light previously overlooked tax compliance opportunities. One of the more well-publicized opportunities involves permitting taxpayers to write off the remaining adjusted basis of retired building structural components. This new opportunity has a significant exception: Taxpayers cannot take a loss on the demolition of an entire building.


Historically, taxpayers were permitted to take a loss on the demolition of a building as long as they did not intend to demolish it upon purchase. If a taxpayer intended to demolish a newly acquired building, the taxpayer had to capitalize any basis allocable to the building to a non-depreciable land account. This harsh result led to frequent litigation between the Service and taxpayers. After decades of disputes, Congress enacted Code section 280B in 1984 to settle this area of contention. This Code section requires taxpayers to capitalize to non-depreciable land accounts the remaining adjusted basis of a demolished building plus the costs of demolition. Code section 280B itself has no exceptions for when or how the building was acquired or why it was demolished.


For many years afterwards, section 280B remained on the books with little explanation. In 1994, the Tax Court held in De Cou v. Comm’r, 103 T.C. 80 that a taxpayer could take a loss on a building abandoned due to unforeseen and extraordinary obsolescence even though it was later demolished. This permitted some taxpayers to take a loss on a building. In 1995, the Service provided a safe harbor in Revenue Procedure 95-27 for section 280B: a refurbished building will not be considered demolished as long as both: 1) 75 percent or more of the existing external walls are retained as internal or external walls, and 2) 75 percent of more of the existing internal structural framework is retained in place. Without looking at other statutory provisions, this safe harbor allowed taxpayers to demolish significant portions of a building, recognize a loss, and not capitalize those portions’ adjusted bases and demolition costs to land.


Even though the section 280B safe harbor did not prevent taxpayers from writing off retired structural components, for many years the Service took the position that retired structural components could not be written off under the MACRS rule that prohibits the component depreciation of buildings. When Treasury released temporary regulations on the disposition of tangible assets, this long-standing policy was reversed. According to the temporary and proposed reliance regulations, with proper substantiation and making the proper elections, taxpayers can now write off the adjusted bases of retired building structural components unless section 280B applies.


Based on the safe harbor of Revenue Procedure 95-27, taxpayers can write off the adjusted bases and demolition costs of retired structural components as long as the two safe harbor requirements are met. Tax practitioners should consider this major limitation of the new disposition regulations when advising their clients of the tax consequences of substantially renovating a newly acquired building.


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