Land value, improvements and depreciation

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Land value, improvements and depreciation

Michael X.
OH · Member since 2011 · 38 posts · 4 votes

This is a scenario that I have not run across before. These numbers are roughly based off of the auditor's website.

A commercial property has a higher land value (100k) than the depreciable improvement value (60k). The building is very run down and could be worth a lot more if it would be renovated and this is what I am planning to do. Normally when you purchase a property you base the depreciation off of the auditor's numbers. So the question is...

How do I increase the depreciable (improvement) amount on my taxes after I renovate the property? Do I have to wait for the auditor to revalue the property of should I just get an appraisal for documentation? If I do get an independent appraisal which I use on my taxes and the next year the auditor reappraises for a different number does the IRS begin to ask questions?

Like any investor, I would like to maximize my depreciation and minimize taxes on the property at the same time. Any ideas? I want to make sure that my appraisal does not trigger any IRS "oversight".

Also, if I plan on renting out the building how do I account for the upcoming property tax increase in the lease before it actually goes into effect? I would hate to write a lease then lose a good portion of the cash flow when the auditor reassesses the property.

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  • Jeff Thompson
    San Diego, CA · Member since 2011 · 86 posts · 9 votes
    14y

    I stumbled upon the "online text book" for this real estate "Renaissance goldmine" program. I don't have it nor have I tried it's methods, but in there it mentioned Componentizing to maximize depreciation. That may be worth looking into.http://www.rgmtextchapters.info/chapter_12.html
    http://rgmtextchapters.info/table_of_contents.html

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  • Bill Gulley
    Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    14y

    Have you bought the property yet?

    In your purchase contract you can say that you are buying the improvements for 160,000 and the land for 40,000....so long as it is reasonable.

    By "auditor" if you mean the tax assessor, they have nothing to do with your book value or cost of acquisition.

    Your book value to begin with is the lower of market or cost of acquisition, generally, how that is divided is based on your contract if it is stated, you can further look to different depreciation methods to an adusted basis.

    If you already own it an appraisal is used if the assets were not valued in the contract. After that you can use a tax assessment as a justification to set values, but the tax assessor does not set your value for IRS purposes. This is from an accounting point of view and I don't know if any state law in your state would apply to the issue, I doubt it. Good luck

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  • Don KonipolBusiness Member
    Investor · The Woodlands TX / Avon, CT · Member since 2009 · 6k+ posts · 10k+ votes
    14y

    Any amount you spend on capital improvements is automatically added to the improvement value of the property and can be depreciated.

    Private Mortgage Financing Partners, LLC
    WebsiteView Page
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  • Ken Latchers
    Hatfield, PA · Member since 2012 · 1k+ posts · 629 votes
    14y
    Originally posted by Bill Gulley:

    In your purchase contract you can say that you are buying the improvements for 160,000 and the land for 40,000....so long as it is reasonable.

    If he said the land was worth $100,000, I don't see calling it as worth $40,000 as reasonable.

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  • Michael X.
    OP
    OH · Member since 2011 · 38 posts · 4 votes
    14y

    Thanks for all of the replies. I haven't purchased the property yet just gathering information. I will write this up in the contract as Bill Gulley suggested.

    So if the purchase price of this property was 300k could I arbitrarily assign 250k for the building and 50k for the land in the contract?

    Is there a certain percent or ratio that I should keep within to make it legit? I assume that the IRS would not like a 299k building and 1k land deal.

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  • Bill Gulley
    Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    14y

    I did say what was reasonable, my example had nothing to do with your deal....land is about 20% of a property value, at least in my area. I suggest you ask an appraiser what they generally see as land values being for similar properties or better yet get comps. This will justify your amounts and they will then be raesonable. Justified. Nothing should be arbitrary. Put it in your sale contract and go from there. Good luck

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  • Kyle Meyers
    Residential Landlord · Indianapolis, IN · Member since 2010 · 592 posts · 138 votes
    14y

    The link Jeff Thompson shared has some great information, I actually just heard Al Aiello speak this week and he really knows what he is talking about. The most important part of cost segregation is reducing the value of the land as much as you reasonably can since land doesn't get depreciated. At a minimum, you can apply the percentages from the appraiser to your purchase price to determine the starting values of land and improvements and then add all of your improvements to the improvements portion, no reason to use the percentage on your after repair value. To be even better set up to take advantage of depreciation benefits, read the information in the link above and research more about cost segregation.

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  • Jeff Thompson
    San Diego, CA · Member since 2011 · 86 posts · 9 votes
    14y

    Kyle Meyers: It does appear to be a great product.

    Seems reasonable to me that the depreciation amounts should be based on the actual value of the improvements instead of some arbitrary percentage of the purchase price.

    Lets say you own two very similar properties only differing in location: one is in Dayton Ohio and the other is in San Diego CA. Is the replacement cost of the buildings and intrinsic value in them really all that different? Yet, the amount depreciated will be drastically different in most cases. One could argue the land value in some cases is essentially nil.

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  • Bill Gulley
    Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    14y

    I guess anything can be made difficult. No, intrensic or replacement values have nothing to do with your valuation of cost or market, whichever is less. You can look at replacement costs, but that would be a new building so in the assessment your would need to depreciate for its age, segregation methods can split out various improvements made over time to adjust the valuation.

    The goal is to keep land at a lower value when you start your depreciation schedules.

    I have not heard of any IRS auditor attempting to pick apart depreciation on a rental, not saying one has not, but it seems it would be a very inefficient use of time in an audit for something under 750k or so. The initial question I think would be two fold, was the value reasonable based on the transaction and secondly, is the depreciation method use consistant and properly applied to the property......if the answers are yes to each I doubt you would have any problem.

    And yes, you want to depreciate improvements usually, unless you want to write off less at the sale and that depends on holding time and just muddies the waters....

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  • Michael X.
    OP
    OH · Member since 2011 · 38 posts · 4 votes
    14y

    Jeff Thompson

    The link you posted has some serious information and I'm still digesting most of it. I will have to read over it several times.

    Thanks!

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