Income tax depreciation or capitalization question

[TerryinMD]

It's that favorite time of year again..... /forums/images/graemlins/tongue.gif

I'm in the process of preparing a site for a new barn/shed to be used for business purposes on our property. In order to get a nice level spot, I've had to get nearly twenty loads of fill to prepare the building. /forums/images/graemlins/shocked.gif And need a few more!!!

How do you report this for income tax purposes? I've looked over some of the various IRS documents - may as well read an instruction guide for some foreign built furniture or such!!! /forums/images/graemlins/crazy.gif I cannot figure out how to categorize this.

Anyone been through this exercise before??

Terry

 

[DUMBDOG]

This would be considered a land improvement, and added to the cost of the land, it would not be depreciated or expensed.

 

[rdln]

Actually I dont know, but my first thought is that it would be all part of the new building and could be expensed up to whatever the limit is now in the tax year that you put the building into service if you have enough income otherwise depreciate over 10? yrs.

but for way down the road you want to put it with all of the other receipts if when you sell and meet the minimum real estate capital gain minus improvements. I didnt think I needed to worry about this and stopped keeping receipts but you never know with land values going nuts.

 

[OkeeDon]

I'm not a tax expert, and there isn't even a Holiday Inn in my neighborhood, but I think that regardless of how you categorize it, it's a capital improvement item, for now. You can't depreciate anything unless it's been capitalized, first. Expense items are items that are not capitalized.

The section 179 expensing of an item alluded to above is somewhat of an exception in that the item can be expensed the first year if all the tests are met, but it still refers to items that were initially capitalized. In other words, you buy a physical item (such as a file cabinet or a tractor implement) and it is capitalized. Then, you either expense it under 179 or depreciate it over it's useful life or use accelerated depreciation.

In the case of your land improvements, I think you could go either way. Categorize it as land, which, as was explained above, you don't depreciate, but the improvements go to increase your basis and lower your potential capital gains tax. Or, you could say that you would never have needed to bring in the fill except that the building requires it, and therefore categorize it as part of the building. In this case, you could depreciate the cost of the fill along with depreciating the rest of the building. Remember, however, that if you ever sell anything that you have depreciated, you will have to recover the depreciation when figuring your capital gains.

Regardless, for tax purposes, in order to categorize the outlay of cash, you should set up a capital asset called "new building" and credit all of your outlays to the asset account. If you'd rather treat the fill as a land improvment, you should already have set up an asset account called "land", and credit the outlay to this account, so you have a record when if and when you are ready to sell the property. You credit all of your capital improvement dollars to such accounts, and debit the accounts with any depreciation you take.

The short answer to the actual question you asked is you don't report capitalization to the IRS, and you can't report any depreciation until you actually have a capitalized asset to depreciate.

 

[Alan L.]

The IRS would most likely consider the cost of bringing in dirt to make a level spot a part of the cost of the land, which is not depreciable or deductible. Whereas, digging and removing soil for the foundation would be considered part of the cost of the building, depreciable over 20 years (assuming its a farm building).

Keep in mind this is a fairly grey area - dirt in, dirt out, not a clear distinction. The IRS has taken the position that if the building was destroyed and you would not have to perform that phase again to replace the building, then it must have related to the land, and not the building.

There is no "expensing" election for the cost either way. That (section 179) does not apply to buildings.

 

[jpr62902]

Great comments from Alan and Okeedon! Now here's my question to you, Alan. Wouldn't the cost of the dirt then be added to the basis of the property for tax purposes? If so, isn't that largely irrelevant if this property is a personal residence, subject to that capital gains tax exclusion up to $500,000.00 (I think that's the right number)? Unless, of course, the capital gain is over the exclusion.

 

[DUMBDOG]

You have just opened up a new can of worms. You are referring to the personal exclusion of a personal residence sale, however we have now added business property to the personal residence. So now you have two types of proerty rolled into one, there is the business portion and the personal portion. To be correct, there would have to be an allocation of the sales price between the business portion and the personal portion, with no gain excluded on the business portion.

 

[Junkman]

If the business is a corporation, then you can have the corporation take the cost of the fill and depreciate it as leasehold improvements over the term of the lease. If there is no separation between the business and personal such as a corporation, then it would just be added to the cost of the land and deducted from the capital gain when the land is sold and whatever tax consequence that would be in place at that time. The tax laws are always in flux and constantly changing. That is what keeps CPA's in business. I stayed at a flop house last night, so my opinion on the matter might not be as relevant as some of the others that stayed at Holiday Inn. /forums/images/graemlins/grin.gif /forums/images/graemlins/grin.gif /forums/images/graemlins/grin.gif

 

[Junkman]

For a "Dumbdog", you are quite correct and very smart to pick up on this. Is there ever such a thing as a simple question and answer on TBN?????? /forums/images/graemlins/grin.gif /forums/images/graemlins/grin.gif /forums/images/graemlins/grin.gif /forums/images/graemlins/grin.gif /forums/images/graemlins/grin.gif

 

[BillyP]

Why couldn't you wait and add it to the total cost of the building, then depreciate it from there?