What expense category is Demolition Costs?

When a business acquires property with an existing building that needs to be removed to make way for new construction or a different use, the costs of tearing down that structure are known as demolition costs. A common mistake is to assume these costs are a currently deductible business expenses.

However, the IRS has very specific rules for these expenditures. Understanding the correct tax treatment is essential for any accountant or business owner involved in a real estate project. This guide will clarify how to categorize demolition costs to ensure your business remains compliant with tax law.

The Demolition Costs Category

Demolition costs are not a currently deductible business expenses. According to IRS Publication 535, any amounts you pay or incur to demolish a structure must be capitalized.

Specifically, the IRS states that these costs must be added to the basis of the land where the demolished structure was located. They are not added to the basis of the new building you construct.

Important Considerations When Classifying Demolition Costs

The tax treatment of demolition costs is unique and requires careful attention to detail.

No Current Deduction or Loss Allowed

This is the most critical rule. You cannot deduct the costs of the demolition work in the year you pay for them. Furthermore, if the building you demolish has any remaining undepreciated basis on your books, you cannot claim that amount as a loss in the year of demolition. That remaining basis is also added to the basis of the land.

Costs Are Added to the Basis of the Land

By capitalizing demolition costs to the land's basis, you are increasing your total investment in the land itself. This has a significant long-term implication.

Land Is Not Depreciable

As explained in IRS Publication 946, you can never depreciate the cost of land. Because demolition costs are added to the land's basis, you cannot recover these costs through annual depreciation deductions. 

The only time you recover these costs for tax purposes is when you eventually sell the land. At that point, the higher basis will reduce your taxable gain on the sale.

Also Read:

• What are Business Expenses?

Examples of Demolition Costs

The costs that must be capitalized to the basis of the land include all expenses directly related to tearing down a building. Examples include:

• Fees paid to a demolition contractor.
• The cost of hauling away debris.
• Expenses for grading the lot after the structure is removed.
• Any remaining adjusted basis of the building that was torn down.

Scenario: You purchase a parcel of land for $200,000 that contains a small, unusable warehouse with an adjusted basis of $30,000. 

You pay a contractor $20,000 to tear down the warehouse and clear the lot for a new office building. 

This results in your new basis in the land being $250,000 

($200,000 purchase price + $30,000 remaining basis of old building + $20,000 demolition).

Tax Implications and Recordkeeping

Because demolition costs are not a current expense, their reporting and documentation differ from other business costs.

How to Report Demolition Costs

You do not report demolition costs on your Schedule C or other profit and loss statement as an expense. Instead, the costs are recorded on your company's balance sheet as an increase to the value of the land asset.

What Records to Keep

It is essential to maintain meticulous records of all demolition activities. These records are necessary to accurately calculate the adjusted basis of your land, which will be critical upon its future sale. Supporting documents should include:

• Purchase documents for the original property.
• Invoices from demolition contractors.
• Proof of payment for all related services.
• Records showing the adjusted basis of the building that was demolished at the time it was torn down.

How Fyle Can Automate Tracking for Demolition Projects

While demolition costs are capitalized, Fyle provides the perfect system for capturing and organizing the expenses as they occur, providing a clean audit trail for your accountant.

• Track Project-Specific Spending: Code all demolition-related invoices and payments to a specific Project, such as New Site Preparation, for clear cost aggregation.
• Centralize All Documentation: Have contractors email invoices directly to Fyle, and attach all permits and contracts to the expense records for a complete digital file.
• Create a Clear Audit Trail: Fyle provides a time-stamped, unalterable record of every cost, which is crucial for substantiating additions to the land's basis.
• Automate Your Accounting: Fyle’s direct integration with QuickBooks, Xero, NetSuite, and Sage Intacct allows your accountant to easily sync the costs and make the correct journal entry to capitalize them to the land asset account.