Last year I converted my primary residence into a rental property. We purchased the home for $295k in 2006 and it lost value over the next few years, now at around $250k. Per the IRS, I need to use the $250k for depreciation purposes.
In order to determine the ratio of the improvements to the land I looked at my assessors website where they say that the land is worth $170k and the improvement $50k. That puts the land at 77% of the value and my depreciable amount at $57k! The home is a 1000 sf ranch and according to my insurance policy has about $150k replacement cost. Question is am I stuck with using the $57K or can I justify a higher amount.
Hi @Jeremiah O'Neill ! Leominster here. For tax purposes, you want to get as much of the value into the improvements as you can. You will need to justify whatever number you decide on so the best thing to do is look at vacant land comps in your area and use a similar value for an average of nearby comps. It's likely being in Cambridge that land values are in fact high. Don't always go by the Assessor's office. They use a completely different set of data to come up with their annual valuations. I just checked on a property I own here in Leominster,a similar sized ranch (1,088 SF). Assessors office has it valued at $179K with the land being worth $65K. I'd say in my case that's a fairly accurate value on the land although I converted it to an investment property about 10 years ago so the numbers were much different then for my basis. I would likely push down that $65K if I was putting it into service today if even by 10-15% to help a bit. ARV on my house is about $200K right now as a comparison. You could honestly go down 15% off of the ARV of a similarly valued piece of land in your area and what is the harm done? I know that when it comes to an audit, the IRS requires 85% of audited expenses to be accounted for as an example so you are still within that allowed 15% margin of error so to speak. You gave it your best shot coming up with a value. Maybe you will find comps in your area are well below that $170K value the Assessors office puts on your land. At the same time, you may find that house lots in that neighborhood are selling at a premium. Good luck...
@Rob Beland Thanks for the response. My property is actually in southern NH, Windham to be specific. I will look at some land comps, and hopefully that gives me a more reasonable value, I am really hoping $50k is not where I end up!
Is using the replacement cost not a reasonable and defendable approach?
Replacement cost from an insurance perspective is the cost to rebuild the structure if it were to burn down. If you use that and back into a land value you are at about $100K. Does that sound reasonable for a building lot in that neighborhood?
There are not many land sales in the recent past, and the comparable ones I am seeing are selling around the $170k, so using that I would be looking at about $80k for the improvements depreciation value. Lower than I was thinking, but not sure how I could justify anything higher.
Make sure when you are calculating your land values you are using an "improvement ratio" as that's how you can determine your land values and provide the best support for your assertion. For instance, if the assessor's office claims your land is $50k and your improvements are $150k, your improvement ratio is 75%, leaving 25% for land. So if you buy the property for $100k, you can claim the land is only worth $25k (25% of $100k) regardless of what the assessor's say or comps around you.
You will want to look at an appraisal and the replacement cost method from your insurance to determine what gives you the best (read lowest) land value.
Using this method will allow you to easily defend yourself in the event of an audit. Let me know if you have any questions.
*Edit - and as Rob pointed out, you can also use land comps.
Thanks for chiming in. The following are my improvements amounts for various methods:
Assessors ratio- $56k (77% land 23% improvements)
Land comps- $80k (I found a comp that sold at $170k and FMV for my property is $250k)
Insurance replacement cost -$150k
As you can see insurance replacement cost is my best option, but not sure it is defendable. Brandon, have you used this method?
Also, I am struggling with my future cost basis when I go to sell. Since the FMV was $250k when I converted the property to a rental, is this going to be used as my cost basis when I sell. This would completely ignore the fact that I paid $295k for the property 6 years ago, which would mean paying capital gains on a extra $45k.
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