The Role of Basis Allocation in Enhancing Real Estate Value

A substantial tax benefit provided to taxpayers investing in real estate is depreciation. Depreciation is a way that the IRS recognizes the deterioration of an asset over time. This deduction comes at no cost to the taxpayer — besides the initial purchase of an asset, there is no money spent beyond the initial purchase to claim this annual deduction.

One key factor when investing in real estate that affects the annual depreciation deduction is the distinction between nondepreciable and depreciable assets. This primarily refers to the value given to the land versus the building for the purchased property. The more value given to the building and its related improvements can provide a substantial tax benefit to the taxpayer. If more value is given to the land, which is a nondepreciable asset, then the taxpayer could miss substantial tax benefits provided by depreciation.

How should we determine what value to give the land and building? There are a few reliable options — some are more credible than others and will present stronger justification in the eyes of the IRS.

Proportioned Ratio Based on Tax Assessor’s Value of the Land

The county tax assessor offers support to determine the value of depreciable and nondepreciable property. They can provide an assessment of the land and any improvements, which is used to create an apportioned ratio to determine land and building value for any purchased property. While this method is acceptable, it may not be the most favorable option for the taxpayer if the building is less valuable than the land that it resides on. Ultimately, placing more value on the nondepreciable portion of the asset provides fewer tax benefits to the taxpayer.

Appraisal

Commissioning a land appraisal — full or limited scope — is one option that is least likely to be challenged by the IRS if they question the value between the land and building. By having a real estate professional assess the value of your property through an in-depth analysis of sales comparisons, market conditions and other factors, you can protect yourself from potential scrutiny.

Rule of Thumb

Some taxpayers choose to use a general split to the value of the property purchased — such as 80% of the value going to the building and 20% of the value going to the land. Although favorable for the taxpayer when most of the value goes to the building, the IRS has scrutinized this position in the past due to the actual property values often being different from the 80/20 split taken.

Taxpayers should carefully consider the best method to allocate the value between the land and building if purchased under one purchase price. A simple ratio may not provide the best benefit to the taxpayer, and multiple scenarios should be run to maximize this tax benefit given to real estate investors. If you want to get even more depreciation out of your building, a cost segregation study could provide significantly more first-year depreciation. To learn more about Weaver’s cost segregation services and other opportunities for tax support, contact us today.

Authored by Bryan Creel

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