Commercial Real Estate Landlords Can Find Tax Savings in COVID-Related Abandonment Losses by John G. Ebenger, CPA
Posted on February 22, 2021
With all the economic hardships caused by the COVID-19 crisis, businesses must take the time to carefully review their financial losses to uncover potential opportunities for which they may use those deductions to maximize tax efficiency in 2020 and the years ahead. For example, much ink has been spilled over the Coronavirus Aid, Relief and Economic Security (CARES) Act, which temporarily revived the use of net operating loss (NOL) carrybacks to allow taxpayers to generate immediate cash flow in 2020 from NOLs. Far less attention has been paid to existing tax law and the treatment of abandonment losses for taxpayers that own and invest in commercial real estate.
Section 165 of the Internal Revenue Code allows businesses a deduction for “any loss sustained during the taxable year and not compensated for by insurance or otherwise” reimbursed. In general, it is far easier to determine a physical loss to a building or other tangible asset than it is to identify and quantify losses to intangible property. With regard to the COVID-19 pandemic, few taxpayers will find the virus to have caused direct physical damage to their properties. However, that does not mean taxpayers do not have other assets on their books that may qualify for deductions when they or their tenants abandon a commercial property.
Abandonment, or the voluntarily and deliberate surrender of ownership in or use of a property, is not treated as a sale or exchange for tax purposes. Rather, the tax code considers abandonment of tangible or intangible property in which the taxpayer has a cost basis to be a deductible loss that taxpayers may fully write off when they can demonstrate the following:
- The loss can be evidenced by closed and completed transactions,
- The loss was the result of an identifiable event (i.e. COVID-19), and
- The loss was sustained during the year of the identifiable event.
In the context of the COVID-19 pandemic, landlords may have an opportunity to deduct as abandonment losses certain leasehold improvements they made to a property, pursuant to a lease agreement, that the lessee permanently vacated during the crisis period. However, the actual costs a landlord may write off are limited to those leasehold improvements that will not provide any benefit to a future tenant.
As an example, consider a property owner that built out leasehold improvements for a restaurant tenant that closed its doors in 2020 and walked away from its lease due to the impact of the virus. If the landlord believes that the lease is no longer in force and the tenant will not return, he or she may deduct in the current year certain costs for improvement that were unique to the restaurant tenant and not applicable to a possible future lessee. This may include the costs of gas and electrical updates and special plumbing and ventilation systems for a chef’s kitchen. However, if the landlord believes he or she will re-lease the space to another restaurant tenant, it will be more difficult to claim abandonment deductions for those improvements.
Other examples of COVID-related disaster losses real estate property owners may be able to write off on their 2020 tax returns include:
- Complete abandonment of fixed assets, machinery and/or equipment;
- Disposal of spoiled and/or unsellable inventory and supplies;
- Unreimbursed and nonrefundable payments for cancelled events and conferences;
- Certain termination payments made to cancel contracts, licenses or leases; and
- Costs associated with pending deals and other transactions that did not close due to the pandemic.
It is important to note that a decrease in a property’s fair market value is not deductible under the Section 165 disaster loss rules. In addition, casualty losses taxpayers incurred in 2020 and claimed on their 2019 tax returns may not be applied to their 2020 tax return filings. As a final note, certain losses or expenses that are not eligible for a deduction include:
- Increased operating expenses due to COVID-19,
- Covid-19-related business interruption losses, and
- Other normally deductible ordinary and necessary business expenses
As 2021 progresses, real estate owners should continue to look for abandonment losses they may use and deduct on their 2020 tax returns, much in the same way they claimed 2020 losses on their 2019 tax returns, to the extent still allowable under the law.
About the Author: John G. Ebenger, CPA, is a director in the Real Estate Tax Services practice of Berkowitz Pollack Brant Advisors + CPAs. He works with developers, landholders, investment funds and other real estate professionals as well as high-net-worth entrepreneurs with complex holdings. He can be reached at the CPA firm’s Boca Raton, Fla., office at (561) 361-2000 or email@example.com.