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Maximizing tax write-offs for roof replacements.

There is a small anomaly in the new tax rules for depreciating real property that, sooner or later, should save careful property owners and managers some money. It is easy to ignore, since it relates to a frequently overlooked part of the building: the roof

Roofs are real property, and current law requires real property to be depreciated on a straight-line basis over 27.5 years (in the case of residential real property) or 31.5 years (for nonresidential property). Most roofs, however, are designed to last for far shorter periods of time. Built-up commercial roofs (still the most common type) and most new single-ply systems are designed to last between 15 and 20 years.

This discrepancy places the property owner or manager in an adverse position since he or she will not be able to recover the cost of the asset over the useful life of the asset.

This effect can be minimized, however, by accounting for the roof as an asset separate and distinct from the rest of the building. If this is done, the book value of the roof at the time the roof is replaced can be written off against current year's income. Obviously this results in significantly better cash flow than continuing to depreciate the roof a bit each year.

Case example

An example is probably the best way to illustrate this argument. Suppose a developer owns 100 commercial buildings and the average life of each roof is 15 years. Accordingly, the developer will replace, on average, seven roofs each year. Suppose also that the cost of the average roof is $40,000.

Based on these assumptions, the developer will need to spend $280,000 each year on new roofs. Under the new rules, the owner will receive a depreciation deduction equal to approximately $9,000 each year for the next 31.5 years ($280,000 / 31.5 = $8,889).

At the end of the roofs' 15-year useful life, the net asset value of the roofs installed in any average year would be $145,000 ($280,000 - [9,000 x 15]). If this entire amount were written off in the year that the roofs were replaced, the owner would save approximately $58,000 ($145,000 x 40 percent effective tax rate). This represents more than 20 percent of the amount needed to replace the old roofs.

While the $58,000 is cash in his or her pocket when the roofs are replaced, a complete analysis should also consider the benefit of the alternative, i.c., continuing to depreciate the roofs over the remaining 31.5 years. This would result in a cash savings of about $3,600 each year for the next 16.5 years ($9,000 annual depreciation x 40 percent effective tax rate). At a 10 percent discount rate, this cash flow has a present value of just under $27,000.

Accordingly, careful bookkeeping for roofs as separate assets saves this property owner or manager more than $31,000 each year. Since the proportions remain the same, any property owner should be able to reduce his or her annual reroofing costs by over 11 percent with this suggestion.

It should be pointed out, of course, that these benefits relate primarily to the current replacement of present roofs because the new rules requiring depreciation over such an extended period of time have only been in effect for four years (for all real property placed into service after 1986). Current benefits depend on whether or not it is possible to account for the roof as a separate asset, and the depreciation rules for real property in effect at the time the roof was placed into service. Obviously, the actual number of years the roof was in service and the cost of the roof influence the deduction also.

When is a roof a separate asset?

The Internal Revenue Service has several rules which must be considered in determining whether or not the roof may be accounted for as a separate asset. There are three alternative cases.

First, all roofs that you replace in the future or have replaced in the past may be accounted for as separate assets. This is particularly important for all replacements after December 31, 1986. After this date the current, unfavorable depreciation rules are in effect.

Second, all original roofs installed on buildings constructed prior to 1980 or the roofs on buildings purchased prior to 1980 may be accounted for as separate assets if the "component method" of depreciation was elected. This "method" simply means that the owner elects to consider, and account for, different parts of the buildings (elevators, interior fixtures, and so forth) as separate assets.

Third, the original roofs of buildings constructed after 1979 or the roofs on buildings purchased after 1979 may not be treated as separate assets. The IRS specifically forbade the use of the component method of depreciation after 1979 because they felt it was being abused. Accordingly, a property owner will not be able to treat the roofs on these buildings as separate assets until the initial roof is replaced.

Historical rules for

depreciating real property

The following is a brief summary of the most recent IRS rules for depreciating real property, by date placed in service:
Prior to 1980 Straight-line or a declining
 balance over the estimated
 useful life of the roof
After 12-31-80 Accelerated Cost Recovery
and prior to System ACRS): specifies
3-16-84 the percentages to be used
 over 15 years
After 3-15-84 ACRS: percentages are
and prior to specified, but now spread
5-9-85 out over 18 years
After 5-8-85 ACRS: percentages are
and prior to specified, but now spread
1-1-87 out over 19 years
After 12-31-86 Modified Accelerated Cost
 Recovery System MACRS):
 specifies straight-line
 depreciation over 31.5
 years for non-residential
 real property

As can be seen from this table, the large discrepancy between the common useful lives of roofs and the period over which roofs could be depreciated did not exist until 1987. Nevertheless, property owners might well consider checking their records to see if they have maximized the deductions available from the net asset value of roofs which were replaced prior to the end of the depreciable lives listed above.


Although 15 years was used in the example above and, if properly installed and cared for, roofs should easily last the full estimated life, the fact remains that many, many roofs are replaced prematurely each year. Indeed, thinking of roofs as separate assets for tax purposes might bring a second benefit.

There are few things which make sense for tax purposes that do not also make good business sense. Roofs have unique properties and care requirements, are physically separable from the rest of the structure, and are expensive enough to justify the attention.

In order to manage this or any other asset efficiently, a property owner or manager should be able to understand the costs associated with purchasing the asset and the actual life of the asset; the costs associated with caring for the asset - consulting fees, maintenance and repairs, leak calls, and ancillary costs such as property manager's time; and be able to perform cost-benefit analyses of alternative programs to minimize cash-outflow.

While the current tax law places the property owner in an adverse position with respect to depreciation of roofs, it also provides an incentive which, if recognized and used, can yield far greater benefits for astute managers.

John J. Kelleher is a vice president of M.J. Kelleher & Associates, a roofing consulting firm that assists in the management of over 30 million square feet of roofs across the western United States. He previously worked as a tax accountant at Price Waterhouse in New York and as a lending officer at the Philadelphia National Bank.
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Article Details
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Author:Kelleher, John J.
Publication:Journal of Property Management
Date:Mar 1, 1991
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