Depreciation question when paid less then land value for house/land.
Real Estate Investor · MD · Member since 2008 · 20 posts · 0 votes
I am reading a book “every landlords tax deduction guide”, which was recommended to me from this site. I understand that the 27.5 year depreciation is only for the house and not the land value.
I bought a piece of property where the house was constructed but never finished. I am in the process of finishing the property and use it as a rental. These are not my numbers but I will use as an example:
Land tax appraised value from state records 300k not including any structures on land.
Purchase price of land and half constructed home 200k.
Rehab cost to complete project and get it ready for rental 100k.
How would I break up my original 200k purchase into what part is considered towards land and what is considered part of the existing house which was not completed? Do I have to consider the whole 200k towards the land since the land is valued at 300k?
Even though I paid less for land can I still deduct my rehab costs (100k)?
thanks
This is why, when an investor buys any property the purchase contract should address what part of the sale price is being paid for the land, the improvements and any personal property, if any.
Complete the dwelling before placing it in service as a rental.
Your land can be excluded a couple of ways at this point. 1. take the tax assessment value and use that. 2. Find the % of land to the total value as appraised, then use that % of your purchase price plus costs of improvements may fly as it's a % of what was actually paid. The accounting approach is taking the lower of cost or market value, so at this point you're establishing your actual cost.
So long as your land value is reasonable and can be justified through acceptable accounting practices the IRS usually accepts the value, unless there are really big bucks involved.
Ask you tax advisor, I'm an accountant type but I don't do taxes.
Had you stated the value in the contract, that would have been the agreed price unless you were obviously trying to pull something, like saying you bought a 100K lot for 10K. Be reasonable and be able to justify the basis. :)
Because of the high assessed/implied value of the land I would be tempted to be a little more creative. As the land value in this investment can't be depreciated it would be advantageous to set it up as a land lease/ground rent. Similar to many commercial property holdings.
Assuming no arm length restrictions have your kids/wife hold title to the land in an LLC & lease it back from them as a valid deduction against rental income. (The minimum term I believe is 15 yrs). It certainly lends itself to consulting a well versed CPA !!!
' Payments on a nonredeemable ground rent are not mortgage interest. You can deduct them as rent if they are a business expense or if they are for rental property. '
Yes, but there are arm's length issues since he already bought it, now doing something may take off into the land of sham transactions. Just set the values as customary, the best argument is the % of sale price in it's as is condition, then adding improvements made to the building side as described.
Now, had we considered Pat's suggestion prior to the purchase, may be something could have been done that better suited the situation, but not with related members are probably not with a few residential units as that isn't common. It can be for 100 or more unit projects. :)
Bill,
I guess I should of seeked professional advice before buying the property because I did not separate the cost of land and cost of structures of the property in the real estate contract. The current state tax records only have the improvemnents listed as 16k dollars (which is way undervalued).
I plan on completing the strucure prior to renting (I have no choice the county wont give me occupancy permit until all work is done).
Bill are you saying if the land is worth 300k and a completed comparable house would cost 200k to build (500k total) then 60% of my purchase price should go towards land and 40% of my purchase price should go toward the unfinished house. So my 27.5 year deduction would be 40% of my purchase price (200k * 40%= 80k), plus what ever my rehab costs will be (about a 100k). Again I plan on seeking professional advice I just wanted some opinions.
Pat I need to think about your plan and let the idea sink in still tryting to figure all this stuff out.
Thanks for the advice.
Yes, as to the %.
This might help too.
Build the house and have it appraised or appraise it from plans and specs. The difference in what the appraisal is and what the cost to build is can justify the beginning value of the incomplete improvement. If it costs 160 to build and it's valued at 200, then the beginning value was 40. Sale price -40 = land value at the purchase price. The tax assessment for personal property taxes` is irrelevant, but I say that not knowing if any newer IRS ruling has adopted local tax evaluations required to be used as a basis if not stated in a contract. So, double check with your tax person.
@Steven Hamilton II may know this off the top of his head. :)
With a new build etc segregated depreciation is something you need seriously to review with Steve Hamilton. Along with deductible land prep costs within 100ft of the build
Now if the land was in excess of 5 acres I would look at subdividing to get around the o/all land assessment :)
Hindsight is great isn't it :)
In your example, a total of $200K is paid for the land AND the improvements. If your local taxing authority has an assessed value for the improvement (separate from the land) then use the ratio of the improvement assessment to the total to allocate your $200K against land and improvements.
The message here is that the improvements did have some value that was reflected in your purchase price. (I disagree with Bill Gulley that tax assessed value is irrelevant). If tax records are no help, then consider having a professional appraisal done that does allocate the appraised value between the land and structure -- this will give you an allocation ratio that you can apply to your purchase price. Because the structure is unfinished and uninhabitable, it is feasible that the land will appraise for more than the structure. That should change as you spend money on the rehab -- that money is added to your basis for the improvements which may bring the land/structure value into line.
The answer to your last question is NO. You can not deduct rehab costs. Rehab costs are added to your basis -- not deducted on your tax return. AND, you can not begin depreciating the structure until you have placed the property in service as a rental.
Suggest you consult your own tax adviser for specific details that apply to your circumstances.
@Bill Gulley , @Pat L, and @Dave T basically covered it correctly.
Cost segregation is the route that I would go with new construction. The reason is you already have your exact building costs.
You can use the ratio of your property tax assessment to help you figure out how to apportion out land; you bought your land I'm assuming unimproved.
Clearly the land is not worth 300k. Therefore to rely upon that method would be completely incomprehensible. Go with your actual cost. It sounds as though you will be in to the house for about 300k. How much did you pay for the raw land?
Don't over complicate it. Keep it simple, what did you pay for it.