Breaking big-ticket, long-lived assets into components usually translates into shorter write-off periods for some of the parts. This, in turn, can mean larger, upfront depreciation deductions.
Our tax laws rarely allow separate consideration of the components of any business asset, especially under our standard, no-questions-asked Modified Asset Cost Recovery System (MACRS) of depreciation. The U.S. Tax Court has, however, ruled that some elements of a building may be separately depreciated even under MACRS. And the Job Creation and Worker Assistance Act of 2002 (H.R. 3090), which we reported on in the May issue, has increased the importance of components.
Here’s how component depreciation works. Under our basic tax rules, the cost of most buildings, or “nonresidential real property” as they are called, must be recovered over a period of 39 years. Under those rules, the “structural components” of a building include such parts as walls, partitions, floors and ceilings, as well as all components of a central air conditioning or heating system, plumbing and plumbing fixtures, electric wiring, chimneys, stairs, escalators and elevators and other components relating to the operation or maintenance of a building. But non-structural components are eligible for faster write-offs.
In one situation, the IRS’s chief counsel recently decided that exterior facades, ceilings, guest room electrical outlets, door locks, site utilities and the outdoor pylon sign were all an integral part of an elaborate hotel/casino building, and therefore were subject to 39-year depreciation. However, the wall coverings, millwork, decorative lighting fixtures, kitchen equipment, hookups and emergency power generators qualified for much shorter recovery periods as Section 1245 property—assets used in a trade or business—and qualify for a much shorter recovery period.
The chief counsel reasoned that the exterior facades and outdoor sign were so integrated with the building’s structure and that the ceilings were so connected with wiring, plumbing and ventilation components that neither was likely to be removed. He applied the same logic to the electrical outlets, door locks and site utilities.
In determining that the remaining items were Section 1245 property, the chief counsel reasoned that the wall coverings and millwork could easily be removed and that the decorative lighting does not provide basic illumination.
Similarly, kitchen equipment hookups and emergency power generators do not relate to the operation of the building.
Writing Off the Resort
When it comes to a new resort building or facility, the obvious and necessary systems such as heating, air conditioning and electrical service would be considered structural components of the building and their costs written off or depreciated using the building’s 39-year recovery period.
But many components at ski resorts are specific to the resort business. These items could include special electrical wiring for the various types of equipment that only a ski resort would require, or plumbing for hot tubs, saunas or showers, for example. A sound system, rental service counters, temporary partitions, platforms and specialized carpeting would all seemingly qualify.
Component depreciation also plays a role for those who lease their business premises rather than own it. Thanks to the Job Creation and Worker Assistance Act of 2002, resorts and other businesses are now entitled to an additional first-year depreciation deduction equal to 30 percent of the adjusted basis of qualified property. However, only property with a recovery period of less than 20 years is eligible for this special treatment.
When improvements are made to leased business property, their cost is generally depreciated in the same manner and over the same period as the MACRS deduction for the property itself. The cost of replacing a roof would, for example, be depreciated over 39 years using the straight-line method. If the business does not retain the improvement when the lease is terminated, the deductible loss equals the improvement’s book value or basis at the time the lease was terminated.
Look Back for Future Deductions
As we reported in the May issue of SAM, the 30 percent bonus depreciation is allowable for the year in which the property is placed in service. If, for example, a resort acquires qualified property, either an improvement to leased business property or an item that can be legitimately labeled as a Section 1245, non-structural component of a building, on June 1, 2002, at a cost of $200,000, the resort or business may claim a first-year depreciation “bonus” of 30 percent of the property’s adjusted basis. That’s a $60,000 deduction simply for qualifying the property as a nonstructural component and separating it from the 39-year recovery period required for nonresidential real property. Plus, the remaining basis in the property, $140,000, is recoverable over the shorter recovery period.
Substantiating the breakdown of structural and non-structural components of a resort facility or equipment requires the assistance of qualified professionals and appraisers. As is the case with the new bonus depreciation, deducting the non-structural components of a resort or skiing-related building may require going back in time.
Remember, the bonus depreciation applies to all equipment acquired and leasehold improvements made after September 10, 2001. Separating the short-lived, non-structural components of a building may require amending previously filed income tax returns. The tax savings, however, can make the effort entirely worthwhile.
