[Code of Federal Regulations]
[Title 26, Volume 2]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.165-3]

[Page 893-895]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.165-3  Demolition of buildings.

    (a) Intent to demolish formed at time of purchase. (1) Except as 
provided in subparagraph (2) of this paragraph, the following rule shall 
apply when, in the course of a trade or business or in a transaction 
entered into for profit, real property is purchased with the intention 
of demolishing either immediately

[[Page 894]]

or subsequently the buildings situated thereon: No deduction shall be 
allowed under section 165(a) on account of the demolition of the old 
buildings even though any demolition originally planned is subsequently 
deferred or abandoned. The entire basis of the property so purchased 
shall, notwithstanding the provisions of Sec. 1.167(a)-5, be allocated 
to the land only. Such basis shall be increased by the net cost of 
demolition or decreased by the net proceeds from demolition.
    (2)(i) If the property is purchased with the intention of 
demolishing the buildings and the buildings are used in a trade or 
business or held for the production of income before their demolition, a 
portion of the basis of the property may be allocated to such buildings 
and depreciated over the period during which they are so used or held. 
The fact that the taxpayer intends to demolish the buildings shall be 
taken into account in making the apportionment of basis between the land 
and buildings under Sec. 1.167(a)-5. In any event, the portion of the 
purchase price which may be allocated to the buildings shall not exceed 
the present value of the right to receive rentals from the buildings 
over the period of their intended use. The present value of such right 
shall be determined at the time that the buildings are first used in the 
trade or business or first held for the production of income. If the 
taxpayer does not rent the buildings, but uses them in his own trade or 
business or in the production of his income, the present value of such 
right shall be determined by reference to the rentals which could be 
realized during such period of intended use. The fact that the taxpayer 
intends to rent or use the buildings for a limited period before their 
demolition shall also be taken into account in computing the useful life 
in accordance with paragraph (b) of Sec. 1.167(a)-1.
    (ii) Any portion of the purchase price which is allocated to the 
buildings in accordance with this subparagraph shall not be included in 
the basis of the land computed under subparagraph (1) of this paragraph, 
and any portion of the basis of the buildings which has not been 
recovered through depreciation or otherwise at the time of the 
demolition of the buildings is allowable as a deduction under section 
165.
    (iii) The application of this subparagraph may be illustrated by the 
following example:

    Example. In January 1958, A purchased land and a building for 
$60,000 with the intention of demolishing the building. In the following 
April, A concludes that he will be unable to commence the construction 
of a proposed new building for a period of more than 3 years. 
Accordingly, on June 1, 1958, he leased the building for a period of 3 
years at an annual rental of $1,200. A intends to demolish the building 
upon expiration of the lease. A may allocate a portion of the $60,000 
basis of the property to the building to be depreciated over the 3-year 
period. That portion is equal to the present value of the right to 
receive $3,600 (3 times $1,200). Assuming that the present value of that 
right determined as of June 1, 1958, is $2,850, A may allocate that 
amount to the building and, if A files his return on the basis of a 
taxable year ending May 31, 1959, A may take a depreciation deduction 
with respect to such building of $950 for such taxable year. The basis 
of the land to A as determined under subparagraph (1) of this paragraph 
is reduced by $2,850. If on June 1, 1960, A ceases to rent the building 
and demolishes it, the balance of the undepreciated portion allocated to 
the buildings, $950, may be deducted from gross income under section 
165.

    (3) The basis of any building acquired in replacement of the old 
buildings shall not include any part of the basis of the property 
originally purchased even though such part was, at the time of purchase, 
allocated to the buildings to be demolished for purposes of determining 
allowable depreciation for the period before demolition.
    (b) Intent to demolish formed subsequent to the time of acquisition. 
(1) Except as provided in subparagraph (2) of this paragraph, the loss 
incurred in a trade or business or in a transaction entered into for 
profit and arising from a demolition of old buildings shall be allowed 
as a deduction under section 165(a) if the demolition occurs as a result 
of a plan formed subsequent to the acquisition of the buildings 
demolished. The amount of the loss shall be the adjusted basis of the 
buildings demolished increased by the net cost of demolition or 
decreased by the net proceeds from demolition. See paragraph (c) of 
Sec. 1.165-1 relating to amount deductible under section 165. The basis 
of

[[Page 895]]

any building acquired in replacement of the old buildings shall not 
include any part of the basis of the property demolished.
    (2) If a lessor or lessee of real property demolishes the buildings 
situated thereon pursuant to a lease or an agreement which resulted in a 
lease, under which either the lessor was required or the lessee was 
required or permitted to demolish such buildings, no deduction shall be 
allowed to the lessor under section 165(a) on account of the demolition 
of the old buildings. However, the adjusted basis of the demolished 
buildings, increased by the net cost of demolition or decreased by the 
net proceeds from demolition, shall be considered as a part of the cost 
of the lease to be amortized over the remaining term thereof.
    (c) Evidence of intention. (1) Whether real property has been 
purchased with the intention of demolishing the buildings thereon or 
whether the demolition of the buildings occurs as a result of a plan 
formed subsequent to their acquisition is a question of fact, and the 
answer depends upon an examination of all the surrounding facts and 
circumstances. The answer to the question does not depend solely upon 
the statements of the taxpayer at the time he acquired the property or 
demolished the buildings, but such statements, if made, are relevant and 
will be considered. Certain other relevant facts and circumstances that 
exist in some cases and the inferences that might reasonably be drawn 
from them are described in subparagraphs (2) and (3) of this paragraph. 
The question as to the taxpayer's intention is not answered by any 
inference that is drawn from any one fact or circumstance but can be 
answered only by a consideration of all relevant facts and circumstances 
and the reasonable inferences to be drawn therefrom.
    (2) An intention at the time of acquisition to demolish may be 
suggested by:
    (i) A short delay between the date of acquisition and the date of 
demolition;
    (ii) Evidence of prohibitive remodeling costs determined at the time 
of acquisition;
    (iii) Existence of municipal regulations at the time of acquisition 
which would prohibit the continued use of the buildings for profit 
purposes;
    (iv) Unsuitability of the buildings for the taxpayer's trade or 
business at the time of acquisition; or
    (v) Inability at the time of acquisition to realize a reasonable 
income from the buildings.
    (3) The fact that the demolition occurred pursuant to a plan formed 
subsequent to the acquisition of the property may be suggested by:
    (i) Substantial improvement of the buildings immediately after their 
acquisition;
    (ii) Prolonged use of the buildings for business purposes after 
their acquisition;
    (iii) Suitability of the buildings for investment purposes at the 
time of acquisition;
    (iv) Substantial change in economic or business conditions after the 
date of acquisition;
    (v) Loss of useful value occurring after the date of acquisition;
    (vi) Substantial damage to the buildings occurring after their 
acquisition;
    (vii) Discovery of latent structural defects in the buildings after 
their acquisition;
    (viii) Decline in the taxpayer's business after the date of 
acquisition;
    (ix) Condemnation of the property by municipal authorities after the 
date of acquisition; or
    (x) Inability after acquisition to obtain building material 
necessary for the improvement of the property.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 74474, 41 FR 
55710, Dec. 22, 1976]