As cities across the U.S. grapple with excess office inventory and evolving community needs, adaptive reuse has become a powerful solution. Transforming underutilized commercial properties, such as offices, warehouses or retail centers, into multifamily housing, hotels or mixed-use spaces can revitalize neighborhoods and create long-term investor value.
From an accounting perspective, however, these projects often blur the line between acquisition, redevelopment and new construction, raising unique challenges under U.S. GAAP. Understanding the proper treatment of capitalization, impairment, componentization and leasing is critical for ensuring accurate financial reporting and compliance.
Determining the Nature of the Transaction
Adaptive reuse projects often start with the purchase of an existing property, which may qualify either as a business combination under ASC 805 or an asset acquisition if substantially all of the fair value is concentrated in a single asset (often the real estate).
Key considerations (ASC 805)
Business combination: If the acquired property includes inputs (e.g., in-place leases) and processes (e.g., property management workforce), the transaction may meet the definition of a business. Transaction costs are expensed. This is more typical when multiple properties are acquired along with an existing property management team, tenant leases are in place, and existing systems are being acquired.
Asset acquisition: This is more common for adaptive reuse when a single asset is acquired without an established workforce and existing systems. The property is recorded at cost (including transaction costs) and allocated among tangible and intangible components (land, building, lease intangibles, etc.) based on relative fair values.
Capitalization of Redevelopment Costs
Once the property is acquired, subsequent costs are evaluated under ASC 970-360 (real estate — general) and ASC 360 (property, plant and equipment) to determine capitalization eligibility.
Capitalizable costs:
Property purchase price and directly related acquisition costs (legal, title, escrow, broker fees, transfer taxes) as well as demolition costs that are part of the cost of the new building or redevelopment project. If the project was purchased with the intent of being completely demolished, all purchase price and related demolition costs are generally capitalized to land.
- Construction materials, labor and contractor costs
- Architectural, engineering and design fees
- Permits, inspections and site supervision costs
- Real estate taxes, insurance and utilities during active construction
- Capitalized interest on project-specific debt (ASC 835-20)
Noncapitalizable costs:
- Preliminary feasibility studies, market research and zoning exploration
- Abandoned or unsuccessful project costs
- General overhead or administrative costs not directly tied to construction
- Marketing, advertising and leasing efforts after project completion
- Repairs, maintenance and operating expenses after the property is placed in service
Pro tip: Developers should maintain a clear cutoff for the “development period.” Once the property is substantially complete and ready for its intended use, capitalization ceases, even if leasing or tenant improvements continue. Post development items like tenant improvements, leasing commissions and FF&E are accounted for like any existing nondevelopment property.
