When you buy business or investment real property, such as an apartment building, you usually pay one lump sum for land, buildings, and other improvements. There’s no cost breakdown.
You can’t depreciate land because it doesn’t wear out. So, as far as depreciation goes, land is useless.
What you need is a way to take that lump sum and allocate it to land, buildings, improvements, and equipment.
Allocating costs to land and buildings for tax purposes is a factual determination initially performed by you, the property owner.
The IRS provides little guidance on how land and building values should be allocated. It simply says that “you must divide the cost between the land and the buildings to figure the basis for depreciation of the buildings. The part of the cost that you allocate to each asset is the ratio of the fair market value of that asset to the fair market value of the whole property at the time you buy it.”
There are many ways to perform this allocation, including the contract terms and cost segregation. You are not required to use any particular method—just a reasonable method. The two most popular methods are assessed value and appraised value.
In conclusion, we recommend to talk with a tax expert if you have questions on allocating costs.
We specialize in helping clients clarify their taxes so they keep more of their money. Many small business owners who come to see us in Fort Worth, TX generally do not understand the tax law enough to explain it to a fifth grader.