An Internal Revenue Service determination released earlier this year may be valuable to both real estate developers and manufacturers of certain types of drywall systems. We’ll explain both the ruling and how it may affect these businesses.
When tangible property such as a commercial building is placed in service, the owner is entitled to a depreciation expense that offsets sales, rents and other income. The tax laws provide a broad range of recovery periods and methods, from immediate deduction for part of the investment in equipment to straight-line recovery over 39 years for non-residential realty. Most commercial developers seek through “cost segregation” planning or studies to classify property used in construction as something other than non-residential realty in order to accelerate depreciation expense off of a project. The net present value of accelerated tax benefits can often be quite significant and is often considered in the project budget and ROI planning stages.
Letter Ruling 201404001 (Jan. 24, 2014) found a distinction between two types of drywall used in non-load-bearing partition systems – conventional and so-called “zip” – for purposes of depreciation expense. It concluded that zip drywall systems can be written off much faster for tax purposes than conventional drywall systems (which are treated as part of the non-residential realty segment of the project). A zip drywall system has been described as follows:
a person can zip the zip tape up without it breaking even after the joint compound has significantly cured. When zipped up, the zip tape removes the joint compound that covers it and then exposes the screws under the tape in a manner that allows screw removal and then disassembly of the zip type partition for removal and reuse in in substantially the same condition after removal as before.
A zip drywall system having the same characteristics would not be treated as part of the non-residential realty. Thus, the IRS should agree that this type of system is generally eligible for five-year double declining balance depreciation. Such a determination would nearly double the net present value of the tax benefit resulting from the accelerated depreciation expense on the partition system (assuming a 5% discount rate).
What does this mean?
For commercial property developers, cash from tax benefits flowing from zip drywall systems may offset or beat the pre-tax cost differential between the system and conventional systems. The benefits certainly should factor into the selection of which system to use, if both are commercially viable.
For drywall manufacturers, this development presents a new premium associated with zip drywall systems that may be partially allocable to the producer through revised pricing of the system itself.