How Much Is Building and How Much Is Land?

How Much Is Building and How Much Is Land?
One of the biggest tax advantages of owning a rental
property is the depreciation you can take on the amount you
paid for the property. Of course, the IRS understands that
land does not wear out. So, only the portion of the
purchase price related to the building and the contents is
subject to the allowance for depreciation. This makes
determining the building/land split a very important
decision. Take for instance a $200,000 home. If you can
justify 10% of the value is for land and 90% is for
building, you can take a depreciation deduction of at least
$6,545 per year. Compare that to the same $200,000 home
with a land value of 30% and a building value of 70%. In
this case, the depreciation deduction is only going to be
$4,580 per year. The result is almost a $2,000 difference
in tax deduction per year.

But how do you determine the value of the land and the
building? There are a few options available. The first
option is to check the county real estate tax bill for the
property. Frequently, county assessors print the estimated
land value and improvements value on the actual tax bill.
These assessed values may be lower than the price of the
property at the time of purchase. So, if you use this
method, you should take the relative values of the land and
the improvements to arrive at the ratio of land value to
total value. Then, you can apply that ratio to your
purchase price to determine the land value for your tax
return.

A second option you can use is comparable sales values
based on appraisals for similar properties in the area.
You can speak to a real estate agent to find out what
appraisers are using for land values in the area.

A third option to determine the split between building and
land is to use an industry standard for the area. This
standard could be anywhere from 80% building and 20% land
in some areas, to 30% building and 70% land in other areas
where land is at a premium - many areas in California and
Hawaii come to mind. Although it is rare for the IRS to
challenge an industry-standard split, in the event of an
IRS challenge, you may be forced to go back to one of the
first two methods.

We find industry standard splits to be the most common
method of allocating the purchase price between land and
building simply because they are so easy to apply. With
recent escalations in the prices of real estate throughout
the country, however, this may be an area the IRS chooses
to examine. We recommend that the industry standard be
viewed as a last resort and encourage everyone to at least
explore the other options simply because they provide good
support for the IRS and they may even provide you with a
more advantageous allocation.

Be sure to review these options with your tax preparer
before they begin preparing your tax return.

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Tom Wheelwright is not only the founder and CEO of
Provision, but he is the creative force behind Provision
Wealth Strategists. In addition to his management
responsibilities, Tom likes to coach clients on wealth,
business, and tax strategies. Along with his frequent
seminars on these strategies, Tom is an adjunct professor
in the Masters of Tax program at Arizona State University.
For more information, visit
http://www.provisionwealth.com.com .