Depreciation deductions are deductions that are often misunderstood. Here is a recent example:
Sandy took depreciation deductions for his buildings (rental properties) but not for his land. The basis (depreciable cost) of each building was based on his tax preparer’s allocation of value to the buildings and land.
The IRS disputed the allocation and reduced the deductions, claiming that too much value was allocated to the buildings, which could be depreciated, and too little to the land, which could not be depreciated.
Held: For the IRS. The IRS made its own allocations between land and buildings using the same ratio used in local property tax assessments. The taxpayer argued that its tax preparer made the allocations based both on extensive experience and standard calculations the preparer used for other properties. But the court said this argument did not show why the IRS allocations were wrong, and it is the taxpayer—not the IRS—that bears the burden of proof.
Other depreciation issues. The owner claimed depreciation deductions for replacing the roof, for installing new carpets, and for painting walls under §1245, Gain from dispositions of certain depreciable property. Also, the owner had installed new HVAC units in some properties and expensed them.
The IRS said the HVAC units had to be depreciated, not expensed, and the case went to court.
Held: For the IRS. A roof is considered a structural component, so it is depreciated over the building’s recovery period. Long-lived property—such as HVAC units—is also depreciated, not expensed, using the same recovery period as the building. Central A/C or heating units are structural components, which are long-lived property. But a shorter depreciation period applies to window. A/Cs or units that are otherwise movable. [Smith v. Commissioner, T.C. Memo. 2010-162]
Tip: To increase depreciation deductions, keep separate track of each asset in a building. Replacements and repairs of personal property within a building can be expensed, or can be depreciated over shorter periods when separately accounted for and the owner can show they are not structural components. In this case, the taxpayer did not separately list the cost of painting and the carpets, so those costs were lumped in with the HVAC and roof.