Maybe you’ve installed a new roof, upgraded HVAC, or revamped interiors. But did you know you can immediately deduct the remaining value of what you removed? Most owners don’t, and the IRS does not remind you.
A 2023 IRS study found that real estate investors overpay billions in yearly taxes simply by failing to claim deductions they’re entitled to. Think about that. The money you could reinvest is wasted. This mostly happens due to one overlooked strategy: Partial Asset Disposition (PAD).
What is a Partial Asset Disposition?
Partial Asset Disposition (PAD) is a tax planning technique that allows real property owners to retain a portion of an asset and recognise a loss or gain on the portion they have disposed of. Instead of continuing to depreciate something that no longer exists in the property (like an old roof or HVAC system), you can recognise a loss or gain on that portion of your asset while retaining the value of the remaining part of the asset.
For instance, if you need to upgrade some components of an industrial machine that would originally have cost $75,000 but then you sell them for $40,000, PAD makes it possible to recognise a loss of $35,000 on the replaced components. The IRS permits this under the Tangible Property Regulations, yet most owners do not utilize this.
PAD assists in reducing tax liability, optimizing cash flow, and avoiding excessive overpayments. If all this sounds like rocket science, why not engage tangible property regulations experts like Tangible Property Tax Methods, LLC to not only learn more but also get help saving as much as you can on tax?
How Does a Partial Asset Disposition Work?
PAD operates by determining the replacement residual value of an asset and subtracting the same in the current year of taxation. The procedure involves:
- Determining the asset disposed of: A majority of building items or improvements removed or replaced should qualify.
- Calculating the un-depreciated value: This process is all about identifying the remaining depreciation value of the asset based on cost segregation or accounting records.
- Writing it off: Deduct the loss on your tax return to reduce taxable income immediately.
- Preventing double deductions: Where you are depreciating the disposed of asset, you will want to capitalize the cost of the replaced asset.
Here’s an example to help you understand better. Say, for instance, an owner of a commercial property places a new $200,000 HVAC system in service to replace an existing system with $90,000 of remaining depreciation. Rather than keep depreciating the replaced system even as you begin depreciating the new one, PAD makes it possible to recognise the $90,000 as a loss so you can switch to depreciating the new system.
Why Is Partial Asset Disposition Crucial for Tax Savings?
Most property owners unknowingly overpay taxes by continuing to depreciate assets that have been disposed of. PAD avoids this wastage and delivers vital financial advantages.
- Accurate depreciation: It’s quite costly to depreciate both the components that are part of your property and those that aren’t. PAD ensures you only depreciate whatever’s left in your property.
- Greater cash flow: More accurate deductions result in less tax payments, allowing capital to be reinvested.
- Better Tax Efficiency: This makes it possible to optimise your tax situations by balancing your disposals with the capital expenditures.
What Qualifies for PAD?
Most homeowners believe PAD is only suitable for big jobs. That’s quite far from the truth. You can use PAD for the following elements.
- Building components: Roofs, HVAC equipment, electrical systems, plumbing.
- Interior renovations: Floor coverings, lighting, elevators, interior partitions.
- Exterior improvements: Landscaping, parking lots, signs, fencing.
- Tenant improvements: Leasehold buildouts and alterations.
- Structural elements: Foundations, load-bearing walls, windows, and insulation.
- Replacement of security & technology systems: Fire alarms, sprinkler systems, surveillance cameras, and access control systems.
PAD comes in handy typically when replacing or making improvements to components of larger assets. You can even use PAD when making a late election for a component that you’ve already replaced in a previous year.
How to Maximize Tax Savings with Partial Asset Disposition
To make the most out of PAD, follow these steps:
- Track upgrades and replacements: Record purchase dates, costs, and depreciation schedules with accuracy.
- Perform a cost segregation study: These studies properly allocate asset values, making PAD loss or gain recognition more straightforward.
- Look at past upgrades: You may have upgraded assets in the past few years but not declared PAD. You may be able to revise past returns.
- Consult a tax expert: A tax expert or CPA who is knowledgeable in real estate can guide you through IRS regulations.
- Include PAD in long-term tax planning: All significant upgrades should trigger a re-examination of possible PAD allowances.
Take Advantage of PAD Today
Partial Asset Disposition is the least utilized real estate tax strategy, despite its ability to enhance cash flow and minimize tax exposure. Whenever you renovate or upgrade part of your property, you are potentially sitting on unrealized tax savings.
That’s why you should take the initiative to consult with a tax advisor from a reputable company like Tangible Property Tax Methods, LLC. That way, you can recognise opportunities to utilise PAD better so you’re sure that every dollar of depreciation is working for you.
