Partial Asset Disposition: Part III in a Series Exploring Decision Making Under the TPRs

pic-team-aboutWelcome to the third and final post in our exclusive series focused on effective navigation of the Tangible Property Regulations.  If you’re ready to jump right in, congratulations!  However, if you need a brief refresher, you are welcome to review previous installments at and

So you (or your client) has an expenditure.  Ask yourself the following crucial questions, in the following critical order:

  • Did you newly acquire the property or did a preowned property undergo a major renovation? If so, you must capitalize.  Also, if you acquire and immediately improve the property as planned before acquisition, you must capitalize.
  • Did you make an improvement and are unsure as to whether it must be capitalized or may be expensed?
    • Can this be expensed under one of the three safe harbor elections established under the TPRs? If it can, put your feet up and relax, because you are done.

If the expenditure CANNOT be expensed under a safe harbor…

  • Is this expenditure considered an improvement under the BAR Test? If this expenditure is indeed a Betterment OR an Adaptation, OR a Restoration, it must be capitalized.   [Note:  When applying the BAR Test, an expenditure requires capitalization if it is identified as any one of the three listed options.]

If the expenditure is NOT considered a Betterment, Adaptation or Restoration…

  • Is the value of the expenditure material to its Unit of Property or material at the discrete function level? If the expenditure is not material to its UoP, it may be expensed.  If it is material to its UoP, it must be capitalized.

The TPRs offer a major bonus that is often overlooked — even if it is determined that an expenditure must be capitalized, the TPRs still provide a great opportunity for write offs.  The final regulations permit an election to recognize partial asset disposition (PAD).  This election has tremendous implications for tax savings, and, as we’ll see, is yet another potential benefit associated with the performance of a high-quality cost segregation study.

Before the regulations took effect, there were no written instructions regarding writing off remaining depreciable basis of preexisting assets.   Let’s use the classic roof example.  Back in the day, if you needed to replace your old roof you would capitalize the cost of the new roof, and then depreciate it over the usual class life (39-year for commercial property.)  Before the TPRs, most taxpayers would also continue depreciating the old roof which had been replaced.    It wasn’t that unusual to see two or more roofs on the books simultaneously.

Fortunately, the TPRs allow for the immediate write off of the remaining depreciable basis of the old roof, recognizing a loss in that amount.  This results in lower total income, lower taxable income, and decreased tax burden immediately.  This may also benefit the taxpayer if he sells the property in future.  In a sale, accumulated depreciation often gets recaptured, meaning that some of the proceeds from the sale get taxed at higher rates.  Partial asset disposition removes accumulated depreciation from the fixed asset schedule.  By reducing amounts to be recaptured, the disposition election in essence establishes a tax rate arbitrage, allowing taxpayers to use normal capital gains treatment under Sec. 1250.

An additional bonus of the PAD election comes in the form of deductible removal costs.  It costs money to remove all those old shingles and any bad wood.   The TPRs allow for the deduction of these costs on top of the deduction of the remaining depreciable basis of the old roof.  (Note that removal costs related to demolition are covered under Sec. 280B and are addressed differently.)

Clearly, Partial Asset Disposition is a powerful election that may benefit the taxpayer now and in future.  So why aren’t people clamoring, “I want my PAD!” ?  Part of the hesitation is that determining the adjusted cost basis of the replaced asset has long been perceived as excessively complicated.  The regulations say that taxpayers can use any “reasonable method” to do this, first suggesting that the actual costs be recreated with invoices.  However, many people don’t have sufficiently detailed records.   The PPI method is also suggested in the regulations, as well as making a pro rata allocation.

The best method, in our humble opinion, is the performance of a thorough high-quality cost segregation study that breaks out the costs of all components of the building property.  Don’t take our word for it – the IRS itself says that the engineering-based approach used in a cost segregation study is “the most methodical and accurate approach… and generally provides the most accurate cost allocations.”   Plain and simple, cost segregation generates the detailed, accurate data required to perform partial asset dispositions using methodology that is both accepted and respected.    Furthermore, once a method to determine the basis is chosen, the same method must be consistently applied to any future dispositions on that same asset –  another reason to ensure that your study is performed by professionally trained engineers.   (You may change methods by filing a Form 3115 if desired.)

Let’s return to the critical questions we laid out above, and specifically notice the expenditures that must be capitalized.  These capitalized expenditures each offer the associated option of writing off the remaining depreciable basis of the replaced asset via PAD election.   With their unique focus on breaking out costs, cost segregation studies are the ideal way to generate the data required to justify such elections.  In fact, cost segregation studies are more important than ever – the TPRs have expanded their use far beyond accelerated depreciation, and a properly performed study is crucial for taxpayers who want to see as much benefit from the TPRs as possible.

This concludes our three-part series on navigating the TPR decision process and we’ve just barely scratched the surface of what is, admittedly, a very complicated subject.  We’re here to help – feel free to contact us at your convenience.  We’ll walk you through the process, perform the necessary studies, and design a series of strategies tailored to help you and your clients make the most of the opportunities offered under the TPRs.