Burgess J.W. Raby & William L. Raby have published Demolition Loss, or Something Else?, also available on the Tax Analysts web site as Doc 2006-1944, 2006 TNT 22-53. Here is the Introduction:

The Gulf Opportunity (GO) Zone Act of 2005 set up some special tax rules dealing with demolitions for cleanup costs paid or incurred on or after August 27, 2005, and through December 31, 2005. We have had a few practitioner queries as to what effect the GO Zone Act had on demolition losses generally.

As we see it, the GO Zone Act rules actually do not deal with the demolition losses with which section 280B is primarily concerned. They deal with the out-of-pocket expenses of removing the debris left in the wake of Hurricane Katrina, including allowing 50 percent of the actual costs of demolition. The other 50 percent of the demolition costs is still capitalized as part of the cost of the land under section 280B. In addition to capitalizing demolition expenses, of course, section 280B deals with the unrecovered tax basis of property used in a trade or business or held for the production of income. If a casualty occurs and a structure held for use in a business or for the production of income is thereafter demolished, the basis of the building is first reduced by the allowable casualty loss — which is the lesser of the decline in fair market value as the result of the casualty or the tax basis. Only then is the amount of the demolition loss determined.

In the hurricane situation, there is not likely to be much, if any, unrecovered basis left for nonresidential buildings after taking the casualty loss deduction. In the more general situation, the tax practitioner adds the unrecovered tax basis of the old improvements to the cost of the land. That is seldom the optimum treatment, even though that is what section 280B appears to require. With a little advance planning, there sometimes may be a better way. That better way is the focus of this article.