Cost segregation land value question

Tax, SDIRAs & Cost Segregation
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Cost segregation land value question

Jonathan St.LegerPro Member
Investor · Kitty Hawk OBX NC · Member since 2019 · 44 posts · 39 votes

Hey BP Nation,

@Yonah Weiss

When doing a coat segregation study, how do they establish land vs structure values in a high land cost area? On several podcasts I’ve heard that the land is anywhere between 15 - 20% of purchase price. How would that work on a more valuable piece of land such as oceanfront? Is it still similar and or how does the IRS view it?

Any insight is greatly appreciated!

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Yonah WeissPro Member
Cost Segregation Expert and Investor · Lakewood, NJ · Member since 2017 · 1k+ posts · 1k+ votes
4y

Thanks for the mention @Jonathan St.Leger! Most Cost seg firms are not land appraisers and rely on the client and/or their CPA to weigh in on land value. As you have heard on podcasts, the national average is around 15-20%, but many areas have much less, and other areas, like you mentioned (and California! 🤦‍♂️) can have higher land value, which will in turn lower the total depreciable basis of the building and all of it's components.

Ultimately the IRS will accept the following methods for land allocation.

  • Rely on the county tax assessor’s allocation: A taxpayer can review their county tax assessor’s property allocation, which usually provides an assessment of land and improvements based on the county’s guidelines. This allocation can be found on the most recent property tax bill or on the county assessor’s website. The values listed may not match the total acquisition cost, but the proportionate ratio between the land and improvement values can be applied to the final purchase price for income tax purposes.
  • Commission a full-scope land appraisal: Another option is to commission a full-scope land appraisal. A qualified professional appraiser will generate a comprehensive analysis considering factors such as sales comparisons, highest and best use, market conditions, and income generated following Uniform Standards of Professional Appraisal Practice guidelines. While this option is the most accurate land valuation approach and least likely to be challenged by the IRS, it is also the most costly and can require several weeks to complete the process.
  • Limited-scope land appraisal: A limited-scope land appraisal can be completed by a real estate professional who provides an analysis of sales comparisons or other limited metrics. Similar to a broker's opinion of value, this analysis is less detailed and may not follow USPAP guidelines.
  • Replacement cost method: This methodology is supported by a 1982 tax court case, Meiers v Commissioner (T.C. Memo 1982-51), where the taxpayer successfully argued against the property tax “assessed value” allocation. In this approach, the taxpayer calculated that the cost to construct a new building (say, $300 per square foot at 2,000 square feet, totaling $600,000) should be allocated to building and the remaining balance of the acquisition should be allocated to land.
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  • Yonah WeissPro Member
    Cost Segregation Expert and Investor · Lakewood, NJ · Member since 2017 · 1k+ posts · 1k+ votes
    4y

    Thanks for the mention @Jonathan St.Leger! Most Cost seg firms are not land appraisers and rely on the client and/or their CPA to weigh in on land value. As you have heard on podcasts, the national average is around 15-20%, but many areas have much less, and other areas, like you mentioned (and California! 🤦‍♂️) can have higher land value, which will in turn lower the total depreciable basis of the building and all of it's components.

    Ultimately the IRS will accept the following methods for land allocation.

    • Rely on the county tax assessor’s allocation: A taxpayer can review their county tax assessor’s property allocation, which usually provides an assessment of land and improvements based on the county’s guidelines. This allocation can be found on the most recent property tax bill or on the county assessor’s website. The values listed may not match the total acquisition cost, but the proportionate ratio between the land and improvement values can be applied to the final purchase price for income tax purposes.
    • Commission a full-scope land appraisal: Another option is to commission a full-scope land appraisal. A qualified professional appraiser will generate a comprehensive analysis considering factors such as sales comparisons, highest and best use, market conditions, and income generated following Uniform Standards of Professional Appraisal Practice guidelines. While this option is the most accurate land valuation approach and least likely to be challenged by the IRS, it is also the most costly and can require several weeks to complete the process.
    • Limited-scope land appraisal: A limited-scope land appraisal can be completed by a real estate professional who provides an analysis of sales comparisons or other limited metrics. Similar to a broker's opinion of value, this analysis is less detailed and may not follow USPAP guidelines.
    • Replacement cost method: This methodology is supported by a 1982 tax court case, Meiers v Commissioner (T.C. Memo 1982-51), where the taxpayer successfully argued against the property tax “assessed value” allocation. In this approach, the taxpayer calculated that the cost to construct a new building (say, $300 per square foot at 2,000 square feet, totaling $600,000) should be allocated to building and the remaining balance of the acquisition should be allocated to land.
    6Reply
  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    4y

    @Jonathan St.Leger

    You got a terrific answer from @Yonah Weiss. I will only chime in to clarify the key principle: cost segregation is NOT determining the land value. It extracts land improvements from the land value, and it extracts faster-depreciable items from the building value, but it does NOT establish the breakdown between building and land. Cost segregation is done after the land value is established by one of the methods described by Yonah.

    5Reply
  • Yonah WeissPro Member
    Cost Segregation Expert and Investor · Lakewood, NJ · Member since 2017 · 1k+ posts · 1k+ votes
    4y

    Thank you for clarifying that @Michael Plaks!

    1Reply
  • Natalie KolodijBusiness Member
    Moderator
    Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
    4y

    Yonah Nailed it. 

    Tax Assessor allocation ratio. 

    Appraisal noted land value.

    Replacement cost. 

    I believe there are a couple other methods the IRS has accepted but it woudl be more rare/expensive circumstances. 

    Worth noting that an arbitrary percentage chosen like an 80/20 - is NOT allowed. 

    Podcast Guest on Show Pay Less Tax to the IRS This Year With THESE Real Estate Tax Strategies
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    3Reply
  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    3y

    I'm reviving this old thread because the question popped up more recently on this thread https://www.biggerpockets.com/...
    where one accountant was suggesting to apply a fixed 85/15 allocation - a suggestion which I strongly disagree with.

    Let me add my 2 cents to @Yonah Weiss list above:

    - Review recent local sales of vacant lots or listing for such. Calculate an average $/acre and apply it to your property.

    - Check your insurance policy which often provides the relevant numbers, such as the replacement value of the improvements - for the Replacement cost method mentioned by Yonah

    2Reply
  • Luke Chen
    Investor · New York City, NY · Member since 2016 · 2 posts · 1 vote
    3y

    Thanks Michael for directing me to this thread. It helps with the right understanding.  My question would be practically for small investors with one or few rental properties, what’s the accepted option without adding costs for tax filing purpose?

    In AZ/Phoenix, property tax bill doesn’t separate land and building values. (CA does). Then does that mean we have to pay for land assessment or there is an alternative?


    1Reply
  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    3y
    Quote from @Luke Chen:

    In AZ/Phoenix, property tax bill doesn’t separate land and building values. (CA does). Then does that mean we have to pay for land assessment or there is an alternative?


    I would start by asking local Realtors if they can provide you land value for your properties. Or, if you have access to comps, look for empty lots in the area.

    1Reply
  • Yonah WeissPro Member
    Cost Segregation Expert and Investor · Lakewood, NJ · Member since 2017 · 1k+ posts · 1k+ votes
    3y

    @Michael Plaks thank you for sharing the additional methods. A few accountants have mentioned to me recently that they use a 20% land allocation for all properties, based on a 'safe-harbor'. Are you aware of the source for their claims, and can that be relied upon?

    1Reply
  • Chris McCormack
    Accountant · Edina, MN · Member since 2020 · 172 posts · 97 votes
    3y

    @Yonah Weiss there's nothing in the code that says a ratio suffices. Basis of the land is determined by its assessed value. Assessed value is best determined by an assessor or during the sale but it can also be drawn out by looking at comps.

    3Reply
  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    3y
    Quote from @Yonah Weiss:

    @Michael Plaks thank you for sharing the additional methods. A few accountants have mentioned to me recently that they use a 20% land allocation for all properties, based on a 'safe-harbor'. Are you aware of the source for their claims, and can that be relied upon?


    No such thing, as far as I know. I think it's as much a "safe harbor" as speeding no more than 5 mph. Or 15 mph if in Texas. :)

    What these accountants seem to rely on is the combination of a very low probability of an audit to begin with, and then an even lower probability of an auditor raising the land allocation issue, and then an almost zero probability of the auditor trained well enough to contest it.

    So you will probably get away with 80/20, but it still does not make it right.

    2Reply
  • James Parrish
    Member since 2022 · 34 posts · 22 votes
    3y

    @Michael Plaks

    Some accountants use the 80/20 rule because it's quick and will create more deductions for their client. I just ran into a situation where the land value was assessed at 76%. Always best to do your due diligence.

    2Reply
  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    3y
    Quote from @James Parrish:

    @Michael Plaks

    Some accountants use the 80/20 rule because it's quick and will create more deductions for their client. I just ran into a situation where the land value was assessed at 76%. Always best to do your due diligence.

    In other words, some accountants don't do their job right. Shocking. :)
    3Reply
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