Land Versus Building Allocation and Why It Comes First

Before a study can classify anything, the purchase price must be divided between land and improvements. Land cannot be depreciated. The size of the depreciable base is therefore set by the land allocation. A high land share reduces the base, and a study cannot change that.

The basic rule

The cost basis of a property acquired in a single purchase is allocated among its parts in proportion to their relative fair market values. Land gets its share, and the building, site improvements, and any personal property get theirs. Only the non-land portions are depreciable.

Common sources for the split

• The purchase agreement or closing statement. Sometimes contains an allocation. If both parties agreed to a reasonable allocation, it can be persuasive.
• A real estate appraisal. An appraisal often separates land and improvement values. Ask if the appraisal your lender required provides a split.
• Property tax assessments. Many jurisdictions assess land and improvements separately. The ratio can serve as a reference, though assessments may not reflect market value.
• Comparable land sales. An analysis of vacant land sales in the area.
• Cost approach. Estimating the value of the improvements by replacement cost less depreciation, with land as the balance.

Each method has strengths and weaknesses. Providers sometimes use more than one.

Why the allocation is contentious

A lower land share increases depreciable basis, which is favorable to the taxpayer, so reviewers may look at whether the allocation is reasonable. Using the assessment ratio may be simple but might not be accurate. Using an appraisal is stronger if the appraisal is reliable. A study that adopts an unreasonable land share can draw questions.

Rough sense of scale

In urban or high-value land areas, land can be a large share of the price. In areas with cheaper land, the building can be most of the price. This site does not provide a percentage because no honest generic number applies. Check your own facts.

Effect on the study decision

Suppose your purchase price is $400,000. If land is 20 percent, the depreciable base is $320,000. If land is 45 percent, it is $220,000. The difference in base changes the amount that could be reclassified and the value of a study. In a hypothetical like this, the smaller base could turn a favorable case into a marginal one. See Small and Low-Basis Properties.

Timing

Establish the allocation early, at or shortly after closing. Later, it can be harder to support. Keep the documents that support it. See Year of Acquisition: Why Timing Matters for a Study.

Consistency

Use the same allocation on your return and in the study. If you have already filed with a certain allocation, changing it later raises questions. Ask your preparer.

Land improvements are not land

Do not treat site work as part of land value without analysis. Some of it can be depreciated. See Land Improvements and the 15 Year Class.

Partial interests

If you buy a leasehold or a partial interest, or buy a condominium unit, the allocation involves different components. Ask your preparer.

What to bring to a provider

Share any appraisal, assessment notice, and the closing statement. Ask how the provider will determine the land value and whether they will use your allocation. See What an Engineering-Based Study Typically Includes.

Illustrative allocation methods in words

Suppose a property tax bill shows land at forty percent of the total assessed value. An owner might use that ratio for the purchase price. Suppose an appraisal for the loan shows land at thirty percent. The appraisal is more specific to the property and to the date of purchase, and is often viewed as stronger evidence. Suppose the purchase agreement itself contains an allocation negotiated between buyer and seller. That may carry weight if reasonable. A provider may combine sources and choose a reasoned figure.

Signals that an allocation may draw questions

A land share that is much lower than the local norm, an allocation that changes between the return and the study without explanation, and an allocation that relies on nothing but a preference all invite questions. If the allocation is unusual, document the reasoning.

Recordkeeping

Keep the document that supports the allocation together with the study. If you later sell, the same allocation logic will be used to compute gain, and consistency helps.

A note on condominiums and partial interests

If you buy a condominium unit, the deed conveys the unit and an undivided interest in common elements. Allocation between land and improvements may rely on the association's information or the assessment. Ask your preparer and provider how they will handle it, since the ownership structure differs from a standalone building.

Reasonableness as the guide

The standard is generally a reasonable allocation supported by evidence. An allocation that you can explain with documents is safer than one that you cannot. If you are unsure, ask a provider or an appraiser for a written opinion of value. Cost is usually modest relative to the risk of a poorly supported allocation.

Next steps

Once the allocation is settled, run the numbers with your cautious assumptions. See Cost Segregation Decision Checklist.