One of the best ways to reduce the tax burden of commercial real estate is with cost segregation. If you’re ready to reap the rewards of accelerated depreciation, you’ll need to provide one essential piece of information: land value. Determining this value accurately is key to both IRS compliance and maximizing your deductions—let’s explore how to get it right.
What Is Land Value and Why Does it Matter?
When you purchase real estate, the overall price tag encompasses both the land itself and any buildings or structures on it. For tax purposes, the IRS mandates that you distinguish between these components. Why? Because land is considered a non-depreciable asset, which means you can’t claim depreciation deductions on its value. Buildings and certain land improvements, on the other hand, are depreciable.
To ensure the accuracy of your cost segregation study, we need to know the specific portion of your purchase price that can be attributed to the land itself. If this value is incorrect, it can potentially result in miscalculated depreciation deductions. This could either put you at risk of an IRS audit or lead you to miss out on legitimate tax savings.
How to Determine Land Value
Appraisal Reports
Appraisal reports offer the most accurate and defensible method for determining land value. Professional appraisers conduct thorough analyses, considering location, comparable sales, zoning and potential development restrictions.
It's important to note that not all appraisals explicitly provide a separate land value. While professional appraisals are the most accurate and defensible way to determine land value, there are also several other methods that can be used. Also, it’s not required to have an appraisal to complete a cost segregation study. In many cases, we understand that there may not be one and that’s okay. You would just use one of the alternative methods in this article to determine land value.
How to Obtain an Appraisal
- Find a qualified appraiser: Seek out an appraiser who holds a designation like MAI (Member, Appraisal Institute) or SRA (Senior Residential Appraiser). These certifications indicate advanced education and experience in real estate valuation. You can find qualified appraisers through professional organizations or online directories.
- Understand the process: Be prepared to provide the appraiser with relevant property information, including the purchase price, legal description, survey details and any improvements made. The appraiser will typically conduct a site visit for inspection and collect data on comparable properties in the area.
- Receive the appraisal report: Expect a comprehensive written report from the appraiser that outlines their methodology, analysis and ultimately their determination of your land's fair market value.
Comparable Sales (Comps)
In cases where an appraisal isn't feasible or doesn't include a specific land value breakdown, analyzing comparable sales of raw, undeveloped land in your area can offer a reasonable estimate. Real estate agents are excellent resources for providing land comps data. Consider the average price per acre or square foot of similar land parcels, then apply that value to your property's acreage.
Applying Comps to Your Land
- Compilation: Working with an agent, gather a selection of suitable comparable land sales for analysis.
- Adjustments: Analyze each comp carefully. Did a comp have significantly better development potential? Adjust its sale price downwards accordingly. Did your property have any disadvantages? Factor that in.
- Average vs. weighted average: Consider using a weighted average based on how closely each comp matches your property, giving those greater consideration in the final estimation.
Please note: The comps method, even with real estate agent assistance, introduces a degree of subjectivity. Land can vary significantly even within small areas. It's always best to consult with a cost segregation expert for the most accurate assessment.
Tax Cards
If an appraisal or land comps aren't available, you can use the tax card method as a starting point. Each county has an assessor's office that issues property tax cards. These cards provide the assessed value for both the land and the total property. To make things simple, you can estimate the land value by figuring out the percentage of the total value that's represented by the land and then applying that percentage to your purchase price.
Step-by-Step Instructions
- Visit your county assessor’s office website and search for property records. If they are unavailable, you may need to visit the office in person or submit a public records request.
- Locate the assessed land value written on the tax card.
- Find the total assessed value, which represents the combined value of the land and all structures on the property.
- Divide the assessed land value by the total assessed value. This will give you a decimal representing the land-to-total value ratio.
- Multiply this decimal ratio by your property’s purchase price to arrive at an estimated land value.
An Example
Let's say you buy a building for $1.5 million. An examination of the property tax card shows the land is assessed at $300,000 and the total property value is $1 million.
- Divide the land value ($300,000) by the total value ($1,000,000) to get 0.3 (or 30%).
- Multiply the purchase price ($1,500,000) by 0.3 to get an estimated land value of $450,000.
- Subtract the land value ($450,000) from the purchase price ($1,500,000) to find the depreciable building value of $1,050,000.
National Averages
When none of the previous methods are suitable, some CPAs may opt to apply a national average land allocation (for example, 20%). This is typically considered a last resort, as it may not accurately reflect the unique characteristics of your property and location. The IRS prefers reliable methods like appraisals or comparable sales data to determine land value. Its guidelines stress the importance of using a “reasonable” value.
Conclusion
Accurately determining land value is an important part of your cost segregation study. While appraisals offer the highest level of accuracy, there are other methods available depending on your situation. The most important thing is selecting a method that provides a reasonable and defensible estimate of your land value.
No matter which method you use, the goal is to figure out how much of your purchase price was for the land (which you can't depreciate) and how much was for the building (which you can depreciate). Getting this number right isn't just about following IRS rules—it helps maximize your tax savings.
Ready to reduce your commercial real estate tax liability? Contact us for a free consultation and see how cost segregation can benefit you.
