Land vs. Building Value
A rental property is allowed to be depreciated across 27.5 years (for residential properties). This allows the taxpayer to write off a portion of the building value each year, under the assumption that assets wear out as they age. Establishing the allocation between depreciable building value and non-depreciable land value is a crucial step. Since land value isn't depreciable, finding the lowest allowable land value can maximize the annual depreciation write-off. Here are three accepted methods to achieve this:
1. County Tax Assessor Records: One method involves searching county tax assessor records for property values. Rather than adopting the assessed values outright, focus on the ratio used by the county to allocate between land and building values. Apply this ratio to your property's starting basis.
2. Appraisal: If an appraisal was conducted during the property purchase, it can offer insights into the land value. Appraisals provide a comprehensive evaluation of a property's worth, often distinguishing between land and building values. Utilizing the land value from a reputable appraisal can serve as a reliable basis for establishing the non-depreciable portion of your property's basis.
3. Comparable Land Values: In cases where county records or appraisals suggest unreasonably high land values, exploring comparable land sales can provide a practical solution. Engage a qualified agent or expert to compile a report of comparable land sales in the area. The summary of these transactions can help establish a more realistic and defensible land value for your property. This method ensures that your depreciation calculations are based on sound market data rather than potentially inflated assessments.
Why It Matters: Determining the correct balance between land and building values is crucial for optimizing tax benefits associated with depreciation. Since depreciation deductions are based on the depreciable building value, minimizing the land value allows for higher annual depreciation write-offs. By employing one of these methods to establish the land versus building value accurately, rental property owners can maximize their tax advantages while maintaining compliance with IRS regulations.
What is NOT allowed:
Depreciating the entire purchase price (Except in some condos without land)
Using an arbitrary allocation like 90/10 or 80/20
Applying a dollar amount per square foot