Discussion:Depreciation and the allocation of basis to land and building

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Discussion Forum Index --> Tax Questions --> Depreciation and the allocation of basis to land and building

LPKCPA (talk|edits) said:

3 February 2007
Hello Everyone!

I am working with a client that is going through an IRS examination. The auditor has disallowed some depreciation on a rental house. When the prior CPA put this property on the Schedule E, he used the Accountant's "Rule of Thumb" for land value. He simply took 10% of the value of the home and attributed that to the land. ($200k Cost of property less $20k (10% rule of Thumb) land value) He depreciated $180k for the rental property. When I got the client, I simply kept that assumption.

Now - the client is being audited and the Revenue Agent has gone online to the County Land Assessment web site and found that the land was worth $50,000 when she bought the house. It is right on the web site - he showed me. So he disallowed some of the depreciation based upon the fact that HE was easily able to find the actual land value. However, I told him about the "Rule of THumb" and he wouldn't hear it. However, Accoutants have been doing this for years! I remember when I was a bookkeeper back in the 80's and the CPA's would use 8% for land value. Do we all have to call the Land Assessment offices in order to have done our "due diligence"? The Taxpayer did not give the prior Accountant anything with an actual land valuation on it.

My question to you all today is: Have any of you gone through something similar? ANd does anyone have a good point or idea that I can use to argue my case?

Thanks everyone!

Sandysea (talk|edits) said:

3 February 2007
When I do client's tax returns I take the property appraiser's land value estimate....unusually high in my neck of the woods but it is what the tangible taxes are based upon as well as homestead and home value. When they purchase the property, they get the tax roll and can determine the basis the property appraiser denotes for land....just my opinion, but I don't book the value of the building without a current appraisers taxation assessment....

Chautauqua (talk|edits) said:

3 February 2007
I think it is a poor rule of thumb. The land/building allocation varies widely depending on where in the US the property is located, rural or urban, the age of the building, the size of the lot, and whether we are talking about a condo, townhome, or single family dwelling. The RA has the upper hand in this case because he is dealing with an assessed valuation.

LPKCPA (talk|edits) said:

3 February 2007
I guess I know now that I should get some type of actual land assessment. I agree with what both of you have stated. However, I have heard Accountants using the "Rule of Thumb" for years! Although they never mentioned what to do in an IRS examination situation.....

Lhhesscpa (talk|edits) said:

3 February 2007
Lisa, what the !@>#% is "the accountant's rule of thumb for land value"? I've been a CPA for over 35 years and apparently missed some very important information. Now I under stand why my bosses at my first job as an auditor for a national CPA firm chopped off my thumbs :>)

If there isn't an appraisal from the time of purchase of the property then I would say, yes, you might have some empirical evidence of land value from the property tax assessment date nearest to the purchase date. -- Larry Hess, CPA, Albuquerque, NM - Talk to me

Gosix (talk|edits) said:

3 February 2007
<Have any of you gone through something similar? ANd does anyone have a good point or idea that I can use to argue my case? >

Nope. But you could try the angle that the land value is increased only because the house is on it. Absent the house and its infrastructure, the land decreases in value to your 10% number.

But I think the tax assessment card is going to rule the day.

Death&Taxes (talk|edits) said:

3 February 2007
I did an audit 20 years ago on a rental property at the Jersey Shore, where a condemnation loss had been deducted just before the law changed. Original cost was 168K, land 16K, building 152K and that 7 years before and another accountant. Ridiculous since Grace Kelly's family house was across the street. Auditor wanted to make land 100K reducing the condemnation loss. I had pictures of the old house, pictures of the new and the contract for the new which was 209K. Houses looked very similar. I suggested to auditor we find out what the 209K would have been at date of purchase, using a 9% interest rate to go backwards. He suggested the rate. Since the case was going to be unagreed, he accepted. We had no idea how it would come out. We found the value would have been 140,000 if I recall. We accepted the 12K adjustment; my client said to someone he recommended to me, 'he walks on water.' Lucky, YES! The IRS guy was a veteran but I overheard him telling someone else, "I ran into a condemnation loss this morning; haven't seen that in years."

I doubt this example can be used if the structure is still standing, but assessments themselves are not based on anything objective either and often are political. Yes, the 'old accountant's rule' is twaddle, but so often are tax assessments on land. Location, location, location. Land could be 90% of the value where I live.

LPKCPA (talk|edits) said:

4 February 2007
Death & Taxes:

Wonderful story! I think I can use the facts surrounding your audit of 20 years ago to assist me in formulating a case for my client.

Have to try --- Thanks again for your comments.

Doris Hathaway (talk|edits) said:

22 February 2007
The first thing you should do is check with your insurance company to find out which values are allocated for land and building. If these figures support your argument, you may be able to use this as a defense.

When this fails however, you will probably have to readjust your depreciation deduction in order to account for the increased land value. I recommend that since you have to do this anyway, you may want to partake in asset separation so that you can depreciate your short life assets sooner. This will accelerate your depreciation deduction for at least the first five years.

For example, in your situation you were taking depreciation on $180k building value, giving you a depreciation deduction close to $6500 a year. For your $150k building value, your depreciation should be more like $5400 a year.

If you want to make up for it, this is what you do: Say you find out all the 5 year assets in your property are valued at $10k. So out of your $200k, $50k is land, $140k is the building, and $10k is 5 year assets. If you do it this way, your depreciation deduction for the first five years is about $7 k a year.

So even though you have to increase the value of the land, you can separate your assets, allowing you to keep the same depreciation deductions that you’ve already taken. If you do it my way, you have an even larger deduction than you’ve been taking, so you’re not in any trouble, or at least you won’t owe any more in taxes. In fact, you might even get back a bigger refund because of it. This may even be a blessing in disguise.

Asset separation for residential rentals is available for free. I tell my clients to do their asset separation first before they come to me, it makes my life easier. I recommend the same to you, go to the website to do your asset separation, and your tax person will be able to do the rest.

Doris Hathaway

question from a non-tax pro was transferred here along with one response

PVVCPA (talk|edits) said:

February 23, 2007
The county assessor's allocation of land & improvements is somewhat arbitrary, but it is better data than any rule of thumb. I agree with Doris. Get the replacement value of the improvements from the insurance policy. The insurance company does more due diligence in assigning a value to the home. And their numbers are typically better for the client than the county assessor's numbers.

If it's worth it, for $300-$500 you can hire a real estate appraiser to provide this allocation.

Michaelstar (talk|edits) said:

23 February 2007
In 25 years in public accounting I have never heard of this "accountants - rule of thumb" rule. No wonder the IRS agent took your client to task. If a return with that alocation came across my desk, I would question it as well. The county assessor's valuation may be arbitrary but it is safe and an IRS agent will have no leg to stand on as far as forcing an audit change. We are not in the business of preparing returns so the IRS can just later change them and assess taxes, penalties and interest.

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