The cost of a new roof on a rental property is usually depreciated over a period of 27.5 years. Additionally, roof replacement on a rental property also can create an immediate ordinary loss deduction. When you replace an old roof, the IRS allows you to deduct its remaining book value as an ordinary deduction, provided you meet certain criteria and passive loss rules do not apply. The write-off of the old component creates three major tax benefits for you:
- Immediate ordinary loss write-off. You can claim an immediate deduction for the loss, provided the passive loss rules do not delay it.
- Conversion to capital gain. You convert otherwise unrecaptured Section 1250 gain to capital gain.
- Time value of money. Investing the tax savings from the write-off can generate additional revenue over time.
Example
Consider a building purchased for $4 million seven years ago. You replace the roof and other components. The replacements create a $660,000 ordinary loss. If you're in the 40 percent tax bracket, your immediate cash savings by claiming the deduction is $264,000.
If the passive loss rules delay your deduction until you sell the building, the $660,000 deduction remains available and continues as an ordinary loss at the time of sale.
Time Value of Money
Investing the $264,000 savings at 5 percent after taxes can significantly increase your earnings over time. For example, in 30 years, this grows to $1,086,660.
Additional Savings upon Sale
When you sell this building, the partial disposition election to write off the replacements helps you avoid the 25 percent tax on unrecaptured Section 1250 gain for the disposed assets. This results in additional tax savings at the time of sale.
Making the Election
The process to make this partial disposition election is simple. Calculate the write-off, claim depreciation on the new asset, and deduct your loss on the old asset in your timely filed tax return.
It's important to document this throughout the process of replacing the roof. Don't wait until after January 1s to document last year's deductions.