Depreciation Land Vs Building

[Brown Nathan]

I have always been using a 85% building and 15% land value for calculating my depreciation basis. Now my accountant is saying I have to use the tax basis and the county is assessing most properties in my county at 50% or more land value and these are B or C condition properties on small 50 x 150 lots. Using this rule does not give you much to deprecate.  I was talking with a large CPA firm that charges $1000+ to do a simple return and they were saying that they have been using the 85 15 rule and never had a problem. My current accountant is saying that the irs may come after me on it because I am starting to have a lot of properties and the amount is starting to get significant. I was thinking about going back to the seller and seeing about amending the purchase agreement to say 85 15 as that was one of the items that was mentioned on the irs info on the deprecation. I am wondering what other investiors are doing in this area of deprecation.

[Logan Allec]

"I have always been using a 85% building and 15% land value for calculating my depreciation basis."

Don't just use a standard improvement ratio like 85/15 or 60/40 or something like that.  If the IRS audits you, you have nothing to back up your ratio.

"Now my accountant is saying I have to use the tax basis and the county is assessing most properties in my county at 50% or more land value and these are B or C condition properties on small 50 x 150 lots."

Yes, using the assessor's ratio is the most common method, but by no means is it required to use the assessor's ratio.  If you have documentation of the replacement value of the building (such as from an appraisal, your insurance company, or construction records), that would strengthen your case in the event of an audit.  Say you buy a building for $200,000, and the replacement value of the building is $170,000.  You have good support for an 85/15 building/land ratio.  Also, don't forget that you can carve out personal property from your basis, which will accelerated your depreciation deductions somewhat.

"I was thinking about going back to the seller and seeing about amending the purchase agreement to say 85 15 as that was one of the items that was mentioned on the irs info on the deprecation."

Note that simply having the seller agree to such-and-such an allocation won't necessarily save you.  As the IRS states in Publication 551, "This agreement is binding on both parties unless the IRS determines the amounts are not appropriate."  It is very possible in the case of an audit tha the IRS will determine that whatever was stated in the agreement is not appropriate.

Now, I am a CPA, not an attorney, so I am not qualified to speak to the applicability of a particular court case to your specific situation, but please see below the reasoning of a Tax Court judge in Nicholson v. Commissioner of Internal Revenue, TC Memo 1993-183.  Again, I am not saying whether or not this case applies to your situation.  I have simply posted this for informational purposes only.

b. The Allocation

With respect to both properties, petitioners allocated 20 percent to the land and 80 percent to the building.  In support of this allocation, petitioner argues (1) that the amended escrow instructions with respect to his purchase of the Fresno property so provide, and (2) that such allocation has been held to be reasonable, citing Meiers v. Commissioner [Dec. 38,766(M)], T.C. Memo. 1982-51. We reject both arguments.

The amended escrow instructions (in connection with petitioner's purchase of the Fresno property) provide in pertinent part as follows:

This statement sets forth no basis for the allocation and we perceive none, except perhaps petitioner's foresight in seeking to substantiate depreciation deductions in connection with the Fresno property. We give no weight to that statement.

Further, Meiers does not support petitioners' position. Meiers does not stand for the unlikely proposition that an 80-percent allocation to buildings always or generally is reasonable, as petitioners suggest. Meiers merely held that the taxpayer's investigation regarding estimated replacement costs was sufficiently probative as to make reasonable the allocation, in that case, of 80 percent to the buildings. Moreover, Meiers explicitly stated that "The question [of what allocation is appropriate] is purely a factual one". Meiers v. Commissioner, supra, therefore is inapposite.

Petitioners make no other arguments, and have produced no evidence, in support of their proposed allocation. We are therefore unable to find their proposed allocation to be appropriate. Respondent, however, also has failed to offer any meaningful alternative, arguing that, inasmuch as petitioners' allocation is incorrect, no depreciation is allowable on the San Leandro and Fresno properties. Because we think it clear that some allocation to the buildings is appropriate, zero, a fortiori, is the wrong answer. Accordingly, we will estimate the proper allocation, bearing heavily upon petitioners who have the burden of proof on this issue. Cohan v. Commissioner [2 USTC ¶ 489], 39 F.2d 540 (2d Cir. 1930); Rule 142(a). Based upon the facts before us, we find that, with respect to both properties, 10 percent is allocable to the buildings and 90 percent is allocable to the land.