As featured in Accounting Today
By Lester Cook | Principal, Cost Segregation
Allocating an investment property’s purchase price between land and depreciable improvements directly affects the deductions available to the owner. Land cannot be depreciated, while buildings and qualifying site improvements may be depreciated over their applicable recovery periods.
Cost segregation, often called cost seg, identifies parts of an investment property that may qualify for shorter 5-, 7-, or 15-year depreciation periods instead of remaining on the building’s 27.5- or 39-year schedule. Purchase agreements often provide one combined price, so investors first need a reasonable land-versus-building allocation, which establishes the building basis available for cost segregation and first-year deductions.
Traditionally, determining that split may require investors and their tax advisors to compare assessor records, appraisals, replacement costs, and other valuation information. CostSegregation.com removes much of that manual work through its built-in Land vs. Building Allocation Advisor, which uses available county assessment data to suggest a property-specific allocation.
Key Takeaways
- Land is not depreciable, so the land-versus-building allocation determines how much of the purchase price is available for depreciation and cost segregation.
- Traditional allocation methods may rely on appraisals, county assessor data, replacement costs, or other property-specific information.
- CostSegregation.com’s Land vs. Building Allocation Advisor automatically pulls available county assessment data and calculates a suggested allocation for the investor.
Why Land vs. Building Allocation Matters for Cost Segregation
The IRS does not allow taxpayers to depreciate land because it does not wear out or become obsolete. Buildings and certain land improvements used for business or income-producing purposes may be depreciated.
IRS Publication 946 states that land should not be included in the depreciable basis of real estate. Investors must therefore separate the property’s nondepreciable land value from the building and other depreciable improvements.
That split establishes the building basis available for cost segregation and affects the potential first-year deductions shown in the analysis. Assigning more of the purchase price to land reduces the amount available for depreciation, while assigning too little may create an allocation that is difficult to support.
According to KBKG’s cost segregation experts, land allocation should be treated as a core part of the analysis because it establishes the starting basis used to calculate depreciation deductions.
How Land and Building Values Are Traditionally Determined
When an appraisal does not provide separate land and building values, investors and their tax advisors may consider several approaches:
- County tax assessor allocation: Apply the assessor’s land-to-improvement ratio to the property’s purchase price.
- Full-scope land appraisal: Obtain a detailed valuation from a qualified appraiser using comparable sales, market conditions, and other property-specific information.
- Limited-scope land appraisal: Use a more focused valuation, such as comparable land sales or a broker’s opinion of value.
- Replacement cost method: Estimate the current cost of constructing the building and allocate the remaining purchase price to land.
- Rule-of-thumb allocation: Apply a standard percentage, such as an 80/20 or 70/30 building-to-land split.
An appraisal that provides a separate land value is generally the strongest starting point. However, many appraisals value the property as a whole and do not include the split needed for depreciation.
The county assessor ratio is a common alternative. Rule-of-thumb percentages are generally the least supportable because they may not reflect the property’s location, market, lot size, or improvements.
Additional background is available in Tax Court Rejects Taxpayer’s Land vs. Building Allocation and U.S. Tax Court Summary Opinion 2017-31.
How CostSegregation.com Simplifies the Process
CostSegregation.com handles the land-versus-building allocation inside its self-guided cost segregation workflow. When county assessor data is available, the Land vs. Building Allocation Advisor automatically applies the assessor’s land-to-improvement ratio to the purchase price and suggests the land and building basis.
Users can accept the suggested allocation or enter another supported value, such as one from an appraisal. The confirmed building basis then flows directly into the cost segregation report and first-year deduction estimate; without requiring the investor to search county websites or calculate assessment ratios manually.
Why the Allocation Affects CostSegregation.com Eligibility
CostSegregation.com supports qualifying residential and commercial investment properties with up to $1.5 million in depreciable building basis, excluding land. A property’s total purchase price may therefore exceed $1.5 million and still qualify.
For example:
- Total purchase price: $1,800,000
- Land allocation: $400,000
- Depreciable building basis: $1,400,000
Because the building basis is below $1.5 million, the property may still qualify for CostSegregation.com.
The Land vs. Building Allocation Advisor helps investors understand both the basis available for depreciation and whether the property falls within the software’s supported range.
How Land Allocation May Affect a Future Sale
The land-versus-building allocation may also affect the property’s tax treatment when it is sold.
Land is not depreciated, so there is no depreciation recapture on the land portion. Depreciation claimed on the building, personal property, and land improvements reduces the adjusted basis of those assets and may affect the gain and recapture calculations at disposition.
You can read IRS Publication 544 for additional guidance on sales of depreciable property and depreciation recapture.
A Simpler Way to Complete Cost Segregation
CostSegregation.com traces its methodology to the first-ever self-guided cost segregation software, launched by KBKG in 2016. It was created to make cost seg more accessible for owners of smaller investment properties.
Instead of requiring investors to determine their land allocation and cost segregation classifications on their own, the software walks them through the process. Users can enter their property information, review the suggested land allocation, see an estimate of potential first-year deductions, and decide whether to purchase the completed report.
With CostSegregation.com, the only cost seg software rated 5/5 on Google reviews, the entire process can be completed in less than 15 minutes.
Start Your Cost Segregation Report
A supportable land-versus-building allocation is the starting point for a reliable cost segregation report. CostSegregation.com helps investors calculate that allocation, identify potential shorter-life assets, and generate the completed report through one solution.
Use CostSegregation.com’s free estimate calculator to see your property’s potential first-year deductions.
Real estate and short-term rental investors can also sign up and use the software for free, only pay if you choose to download the completed report.
Frequently Asked Questions
Can you depreciate land?
No. Land cannot be depreciated because it does not wear out or become obsolete. The building and certain land improvements used for business or income-producing purposes may be depreciated. Learn more in IRS Publication 946.
Can short-term rental owners use CostSegregation.com?
Yes. Short-term rental owners may use CostSegregation.com when the property qualifies. Cost segregation can be especially valuable for short-term rentals because they often include assets that qualify for shorter depreciation periods. A cost seg report also supports the accelerated-depreciation portion of the STR loophole strategy. Average-stay, material-participation, and other requirements should be reviewed with a tax advisor.
Can I use CostSegregation.com if the property cost more than $1.5 million?
Possibly. The $1.5 million limit applies to the depreciable building basis, not necessarily the total purchase price. For example, a $1.8 million property with $400,000 allocated to land has a $1.4 million building basis and may still qualify for CostSegregation.com.
