Cost Segregation - Partial Disposition and offsetting insurance proceeds

[Costin I.]

We had a roof damaged in a hail storm and got it replaced and paid (minus deductible) via an insurance claim. This is on a property that had a CSS done on it some 6 years ago when we got it (and placed a new roof at that time too part of the rehab). I talked with our CPA about doing a partial disposition but he thinks that "the insurance proceeds won't be taxable assuming all the money was put back into the property" and the "partial disposition is probably less favorable than doing a direct offset and just not putting new assets into service".

I understand the first part ("the insurance proceeds won't be taxable"), but I disagree with not doing the partial disposition. From my understanding of CSS and partial dispositions, one (taxing insurance proceeds) has nothing to do with the other (tracking depreciation or doubling on depreciating assets). 

CPA and CSS experts, can you help me confirm or correct my understanding? 

[Andrew Abeyta]

I would lean towards reaffirming your position; perhaps advise your CPA to revisit Treas. Reg. 1.168(i)-8.

That being said, we may not have the full fact pattern given we are not able to see your tax return. Certain elections, i.e. GAA, may impact your options.

- R/E CPA

[Kislay Shah]

1. Insurance Proceeds: Generally, insurance proceeds received to repair or replace property damaged in a hail storm are not taxable. This is because the purpose of insurance is to restore the property to its pre-damaged condition. So, your CPA is correct in saying that the insurance proceeds won't be taxable assuming they were used to repair or replace the damaged portion of the property.
2. Cost Segregation Study (CSS): A CSS is a tax planning tool that allows you to accelerate depreciation deductions by identifying and reclassifying certain components of your property as shorter-lived assets. This can result in increased depreciation deductions in the early years of ownership.
3. Partial Disposition: When a component of a property is replaced or disposed of, you can take a partial disposition deduction for the remaining undepreciated basis of that component. This allows you to recognize the loss associated with the disposed component without having to wait until the entire property is disposed of.

In your case, the replacement of the roof due to hail damage would qualify as a partial disposition event. You would be able to take a partial disposition deduction for the remaining undepreciated basis of the old roof that was disposed of due to the damage. This is separate from the tax treatment of the insurance proceeds.

Your CPA's suggestion of not doing a partial disposition and instead offsetting the insurance proceeds with the cost of the new roof might be less favorable in terms of tax planning. By not taking a partial disposition deduction, you would be missing out on potential tax benefits associated with recognizing the loss on the disposed roof component.

[Costin I.]

@Andrew Abeyta - thanks Andrew.

@Kislay Shah - thanks for the effort, but that is (half of) a ChatGPT answer ☮

[Jason Watson]

Very simple. Ask your CPA to give you a tax plan with each scenario. We do this all the time.

[Andrew Abeyta]

Quote from @Costin I.:

@Andrew Abeyta - thanks Andrew.

@Kislay Shah - thanks for the effort, but that is (half of) a ChatGPT answer ☮

Anytime; at your service, friend

[Julio Gonzalez]

@Costin I. Here's an article where I gave an example of how CSS benefits you when it comes to partial asset disposition. I would rediscuss the situation with your CPA as to why they don't think a partial asset disposition would be more favorable. https://www.biggerpockets.com/forums/48/topics/963421-an-ove...

[Zachary Jensen]

Quote from @Costin I.:

We had a roof damaged in a hail storm and got it replaced and paid (minus deductible) via an insurance claim. This is on a property that had a CSS done on it some 6 years ago when we got it (and placed a new roof at that time too part of the rehab). I talked with our CPA about doing a partial disposition but he thinks that "the insurance proceeds won't be taxable assuming all the money was put back into the property" and the "partial disposition is probably less favorable than doing a direct offset and just not putting new assets into service".

I understand the first part ("the insurance proceeds won't be taxable"), but I disagree with not doing the partial disposition. From my understanding of CSS and partial dispositions, one (taxing insurance proceeds) has nothing to do with the other (tracking depreciation or doubling on depreciating assets). 

CPA and CSS experts, can you help me confirm or correct my understanding? 

Your CPA's assertion that the insurance proceeds won't be taxable if reinvested entirely into the property is accurate; however, it's crucial to address the issue of depreciation and potential partial disposition separately.

A partial disposition allows for the recognition of a loss upon the disposition of a portion of a property. In your case, since the roof replacement constitutes a substantial improvement to the property, it could warrant consideration for a partial disposition. This would involve recognizing a loss on the portion of the property disposed of due to the replacement of the roof.

Your understanding that taxing insurance proceeds and tracking depreciation or partial dispositions are distinct matters is correct. While the insurance proceeds themselves may not be taxable if reinvested into the property, the treatment of the replaced asset for depreciation purposes, especially in the context of a CSS, merits careful consideration. It may indeed be beneficial to explore the option of a partial disposition to accurately reflect the change in the property's asset composition and optimize tax outcomes. As Andrew points out, checkout Reg. 1.168(i)-8. for more info on this. Best of luck getting this sorted out friend! 

[Costin I.]

Quote from @Julio Gonzalez:

@Costin I. Here's an article where I gave an example of how CSS benefits you when it comes to partial asset disposition. I would rediscuss the situation with your CPA as to why they don't think a partial asset disposition would be more favorable. https://www.biggerpockets.com/forums/48/topics/963421-an-ove...

That post is exactly my situation, @Julio Gonzalez. But you also mention "Compare being able to write off the $370,000 today versus having to depreciate it over the life of the asset - 39 years - that’s quite a difference!" - is there a chance that what my CPA meant, writing off the old roof at current depreciated value? 

Is this a decision about one or the other - either write off the old roof OR depreciate the new roof? 

Or does partial disposition mean both - write off the old roof AND start new depreciation on the new roof?