A property was purchased in 2018 with a building (non-land) cost of (approximately) $40 thousand. It was in poor condition. A contractor was brought in to renovate the property, and he gutted it; removing the roof, interior flooring, kitchen cabinets, and countertop, all bathroom fixtures, electrical wiring and plumbing. All was replaced with new at a cost of $50 thousand. After the renovation the property was placed on the rental market with an agent, in 2018.
(1) Should the value of the removed items be expensed on Form 8797 Sale of Business Property Part II ("Ordinary Gains and Losses"? Reviewing the IRS's Publication 527 (2018), Residential Rental Property and other examples online this is not addressed and the tacit assumption is all the original purchase price goes into basis to be depreciated. But if a rental asset that was not fully depreciated was replaced the undepreciated basis would be expensed, so I think this is the right way to do it.
(2) Then comes the question is what would be the "value" of the removed items? Are there any allocation formulas? Every Landlord's Tax Deduction Guide references two sources of "cost segregation study software" namely KGKG and TitanEcho that "in theory" could help but cost $400 each. The book notes that the software uses data provided by the user and construction cost data and proprietary formulas to do the cost segregation. If anyone has a more open-source allocation reference it would be appreciated. Would an allocation of 50% of the original building cost be "reasonable"?
Reg 1.48-1(e)(2) definition of structural components
The term “structural components” includes such parts of a building as walls, partitions, floors, and ceilings, as well as any permanent coverings therefor such as paneling or tiling; windows and doors; all components (whether in, on, or adjacent to the building) of a central air conditioning or heating system, including motors, compressors, pipes and ducts; plumbing and plumbing fixtures, such as sinks and bathtubs; electric wiring and lighting fixtures; chimneys; stairs, escalators, and elevators, including all components thereof; sprinkler systems; fire escapes; and other components relating to the operation or maintenance of a building.
now the thing is under code section 280B
the cost assigned to structural components which are demolished are added to land and therefore are not depreciable.
the are no formulas for allocating costs. cost assigned to components are based on age, condition, and other factors.
had you done a cost seg study, those components that were gutted but not defined as a structural component probably could be written off, but again, being in poor shape not much value would be assigned to them.
as I see it you paid most of the $40,000 for the shell and a nominal amount for the items that were gutted.
just so you should know, the IRS has its own valuation experts and the courts value the opinion of experts more than non experts.
A Cost Segregation study can be completed any time after the purchase, remodel or construction of a property.