When you replace part of a rental property, like a roof, you must remove the old component's remaining value from your building basis to avoid double-depreciating it. The old roof's undepreciated value becomes an immediate deduction, preventing recapture as ordinary income later. A cost-segregation study is the IRS-approved way to determine component values at acquisition.
Chapters
Okay. Partial asset disposition. Well, let's start out with, imagine you had a rental property, say a $500,000 building. You carve out $100,000 for land. So you have a $400,000 asset sitting on the books that you're depreciating. Okay. And say like 4 or 5 years in, you realize there's an issue with the roof. Okay. So you have to replace the roof. Say that's going to cost you $50,000, right? So once that's— once the roof is done and paid for, you put it on the books as roof, $50,000, start depreciating it. And if that— that unfortunately is where a lot of tax professionals and a lot of people just— that's where the conversation ends. The reality though is that that building still has a roof, okay? And now we're depreciating technically 2 roofs, but it only has one. So what is the fix for that? Well, that's where a partial asset disposition comes into play, because what we're saying is when we put that new roof on, We're essentially going to remove the old roof. And in this instance, let's just say that the old roof had a value of $25,000. So what we do is we say, okay, the old building was $400,000, $25,000 of that was the roof. So now we're going to remove $25,000 from that $400,000 number. And then we have— so we have $375,000 left on the building that we're depreciating over the course of whatever time is left. There's also a portion of the depreciation that was taken up to that point that is also associated with the roof. Let's just say that's $5,000. So what the way a partial asset disposition works is you would take that $25,000 for the roof, take the $5,000 of depreciation that you already took, net those together. So that's $20,000. Now that $20,000 now of that old roof, that is now an expense. This year, so you added the new roof, and now you're expensing the balance of the old roof. So that's one of the two major benefits from this thing: we get that expense right away, and we are now avoiding depreciation recapture on that asset. Now, what happens though is oftentimes that old roof was never removed. So ten years later, that roof was being depreciated over and over and over again. And then when that building is sold, all that depreciation that really shouldn't have been taken to begin with. Is now recaptured through recapture, depreciation recapture as ordinary income, when it should have been removed from the books completely in a previous year when the new roof was put on. So that's one of the things that you have to kind of take into consideration is removing that old roof, because otherwise you're going to be essentially depreciating 2 roofs that don't exist. Only one exists. And then you're going to be recapturing depreciation on something that actually what should have been an expense that you got the benefit from when you put the new roof on. Now, what if that roof doesn't have— we don't have a defined amount of $25,000. We like, how do we determine what that roof is worth if it's all built into that $400,000 number? Well, what happens then is we have to come up with a value. And the IRS says, look, you can use whatever reasonable, whatever way you want to, as long as it's reasonable. Now, the best way to do that is through a cost segregation study. Now, we talked about that in previous videos. A cost segregation study essentially says, look, here's this building that we just bought. We're going to carve out parts of it, put them into shorter life buckets. And oftentimes things like the roof, HVAC, electrical, these are things that get carved out and have an assigned value at the time we bought the property. So a cost segregation study is generally the best way to go. And sometimes that's a reason if you're considering a partial asset disposition at some point, a cost segregation study might be worth it. in the beginning when you buy that property, just so you have that documentation to go with. The other thing, there's other ways to kind of calculate this. We're not going to get into that right now, but that it can be very complicated and it can be very complicated. We'll get into that if you want. If you have questions about the other ways to do that, I'm happy to talk about that. But so that's what a partial asset disposition is. It can be a very, very good thing to do, something to plan for, something to utilize. In your top— your tax strategy discussion as to what you're going to do in the future if, you know, in fact you do have these types of properties. So if you have any questions, let's talk about that. Hit me up. I'm always here. Talk soon.
