USA Calculating Basis or Real Estate

[bean_counter]

I have a client that purchased commercial real estate, the closing statement includes a credit for future roof repair of $10,000. This building will need a complete roof replacement sometime within the next couple of years.

How would you account for this credit?

Thanks

 

[The Finance Writer]

Your client accounts for the $10,000 as a credit to a liability account. When the roof is replaced, just use that account to cover some of the cost.

 

[kirby]

Your client accounts for the $10,000 as a credit to a liability account. When the roof is replaced, just use that account to cover some of the cost.

If the building cost $300K and the seller gave you a $10K credit on sale, per the cost method you record the building at what you paid for it- which is $290K. That $10K reduces the cost and is not a liability, unless there is an written agreement that you MUST use the $10K for the roof. Absent that, the new owner is not obligated to replace the roof - there is no "liability" to anyone.
Thereafter, if and when the new owner does re-roof, then if that is capitalizable the cost will be added to the cost of the building.

 

[bean_counter]

Thanks for the replies, your answers are exactly the difference of opinion I'm having with someone. I'm taking the same position as kirby. Since the credit is being giving based on the general condition of the roof and not a specific item that will be repaired or replaced for that amount of money I'm considering it a reduction of the purchase price. Can either of you provide any references to support your position, I've not been able to find anything. Thanks...Drew

 

[kirby]

There is no fancy FASB statement on this. This is just the "Cost Principle" which is fundamental GAAP. Again, it just says if you pay x for something then record it at x.

 

[Marshall]

Drew, I agree with you and Kirby. At the closing, it is simply a reduction in the previously agreed purchase price to reflect that the roof needs to be repaired. What your client does with the $10K is up to him.

If your client spends $2,000 to repair the roof now and holds off replacing the roof, the $2K is a repair expense. If he replaces the roof, the cost is a capital expenditure that would be depreciated starting from the date the new roof is placed into service. If he just sells the building without repairing or replacing the roof, it is likely that the condition of the roof would once again be reflected in the purchase price and would affect his gain or loss.

In any case, it is clear that his basis in the property at the beginning is only $290,000.

 

[The Finance Writer]

Sorry, guys, but I'm standing by my original answer. The building cost is still $300K, not $290K.

Based upon the wording of the question, the $10K credit was for "future roof repair." That is a contingency. The roof might never be repaired. In these cases, an agreement is typically executed at closing that the $10K is placed in escrow and refunded if not used for the intended purpose within a specified period of time.

Only the capitalized cost of the roof is reduced by the $10K.

 

[kirby]

Fortunately, we do not need to speculate on scenarios where there are "escrows" and such. Beancounter has first-hand knowledge of this case. So please tell us Beancounter - is there such an "escrow" or written agreement absolutely obligating the purchaser to repair the roof??

And I am unclear on "only the capitalized cost of the roof is reduced by the $10K." Can you expand on that?

And if the $10K is a "contingency" then GAAP says those are disclosed, not recorded. So you cannot "record the 10k as a liability."

 

[The Finance Writer]

Quite correct, Kirby. The $10K is of course only a liability if the seller actually received the funds and is obligated to use them for the intended purpose or return them. I presumed that this is the difficulty for bean_counter -- that is, he has a $10K debit and needs to credit something. If some third party is holding the funds, then bean_counter doen't have a data entry problem using the settlement statement. Since he asked the question, I presume he is confronted with accounting for $10K.

In case I'm right about the $10K, bean_counter should, as you suggest, inquire about the reason a title company officer would separately indicate the $10K on the closing statement rather than reduce the sales price -- which was the adjustment others recommended bean_counter should assume.

 

[AllanMadan]

As far as I'm concerned, the critical piece will be whether the purchaser has a 'legal or contractual obligations' to use the $10,000 for repairs. If it is a general provision, then I don't believe setting up a liability account is correct.

 

[The Finance Writer]

As far as I'm concerned, the critical piece will be whether the purchaser has a 'legal or contractual obligations' to use the $10,000 for repairs. If it is a general provision, then I don't believe setting up a liability account is correct.

Yep, and a "general provision" is usually not described as a specific provision such as "a credit for roof repair." Still...maybe the title company officer made a mistake on the settlement statement by describing a specific provision.

 

[AllanMadan]

practically, it probably doesn't even matter as very shortly, the repair will take place and as such, liability will be removed soon.