Posted by Dave T on September 01, 2000 at 23:52:58:
Ed,
It’s just my opinion, but, if your purchase agreement sets a specific price for the land and a specific price for the improvements, then you have a firm footing for establishing your land basis.
I believe you misunderstood Tom’s suggestion regarding the tax assessment or the appraisal for establishing the land basis. As I read Tom’s post, I believe that Tom is computing the ratio for each and applying the more favorable ratio to his purchase – perfectly legitimate approach.
Now let me play devil’s advocate using your $100K investment property. If you set the land value at $1 and the value of the improvement at $99,999 you do have a larger depreciation expense but you also have a larger tax bite upon sale. Remember that depreciation is recaptured at a 25% rate. Since land can not be depreciated, the capital gains tax on the sale profit on the land is a maximum of 20%. A higher land value does provide some shelter against depreciation recapture.
Question: when buying an investment property, is it wiser to ‘split’ the offering price between the land and the building, rather than make a lump sum offer for both?
Example: SFH, that I plan to buy NOO, for say, $100,000. Can I split my offer $85,000 for the structure and $15,000 for the land, and use the offer, if accepted, to claim a higher depreciation because my cost basis is higher? If so, how far can I push the envelope? It’s clear that I wouldn’t pay a buck for the dirt and $99,999 for the house, red flags would be a-raisin’. But what is acceptable?
I can’t find anything in Publication 946 that addresses this, other than the implication that if I don’t separate the offered amounts, I’ll be stuck with using whatever proportional amounts the local tax district uses for establishing cost basis, which might, but probably won’t, reflect things as they are, particularly with houses converted to rental use after they were originally acquired.
This is probably a dumb question, but I’ve never seen it addressed on this forum.
Thank you Tom, but I was aware of the acceptability of using tax proportionals; however my question was, why use them at all if I can dictate the purchase price of the land and building separately within the purchase and sale agreement? For example, in my principal residence, the tax proportionals run a 45/55 split between land and house, a split I know to be horsepucky, but it suits the tax authority. Now, Publication 527 specifically allows the separation of prices within the purchase and sales agreement, but how far can I push that separation before the IRS calls me to the carpet? 80/20? 90/10? 99/1? I don’t know, and knowing the answer is going to make a definite difference in how I structure my next offer.
BTW, IRS specifically says to use the lesser of adjusted basis or FMV in determining depreciation, so I wouldn’t advertise the use of a more favorable appraisal in the returns. Big Brother may be watching, ya know : )
