The benefits of allocating purchase price to land in real estate transactions

When acquiring real estate, the allocation of the purchase price between land and property can significantly impact financial and tax outcomes. It is common practice for a team on the buy-side of a real property purchase to push as much of the allocation price to the building and leaving as little possible of the allocation price to the land. This is because land is not considered finite thus a business cannot depreciation land. The building in this common scenario is afforded depreciation from a pumped-up depreciable cost basis, resulting in reduced taxable income. Furthermore, it can be taken further with a cost segregation where fixed assets (such as HVAC, electrical wiring, fixtures, sprinkler systems) are carved out of the buildings cost basis with a shorter depreciable recovery period, allowing for accelerated tax depreciation known as “bonus depreciation”. Having said all that, here is why it is beneficial to allocate most of the purchase price to land…

1. Tax Implications

Land is not depreciable, whereas buildings and other improvements are. By allocating more of the purchase price to land, you reduce the amount allocated to depreciable property. The reason to reduce the allocation to depreciable property is to avoid being in a Depreciation Recapture position upon a future sale. When you sell a property, the amount of tax depreciation taken is subject to Depreciation recapture which is taxed at a higher tax rate compared to long-term capital gains rates. By allocating more to land, you minimize the depreciation recapture tax.

2. Property Tax Considerations

Allocating more of the purchase price to land can potentially lower property taxes. Many jurisdictions assess property taxes based on the value of the improvements (buildings) rather than the land itself.

3. Simplified Recordkeeping

Allocating a higher portion of the purchase price to land simplifies recordkeeping and financial reporting. Since land is not depreciated, there is no need to track depreciation schedules and adjustments for land, reducing administrative burdens.

4. Investment Value

Land often appreciates over time, while buildings and improvements may depreciate due to wear and tear. By allocating more to land, you align the purchase price with the asset that is more likely to increase in value, potentially enhancing the long-term investment return.

5. Flexibility in Future Use

Land provides greater flexibility for future development or changes in use. Allocating more to land can be advantageous if you plan to redevelop or repurpose the property, as the land value is likely to remain stable or increase, while the value of existing structures may not.

Conclusion

Allocating the purchase price to land rather than property can offer significant tax benefits, lower property taxes, simplify recordkeeping, enhance investment value, and provide greater flexibility for future use. It is essential to consult with a tax professional to determine the optimal allocation strategy for your specific situation.

Here at Hagger Tax & Advisory, we work with you to understand your situation and future goals to make sure your company is in the most beneficial tax position. You can schedule a free consultation to discuss how this may benefit your business here. If interested in a free consultation, please select a date and time from the following link to discuss. Schedule a Free Consultation

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Email: chad.hagger@hagger-tax.com

Phone: (305) 762-9587