As tax professionals, we know depreciation is one of the most significant deductions for real estate rental properties. However, before claiming depreciation, you must allocate the purchase price between land (non-depreciable) and the building (depreciable). Here’s how to do it properly:
1.Understand the Allocation Requirement
Per IRC §167 and §168, only the portion of the property attributable to the building can be depreciated. Land is not subject to depreciation.
2.Use the Sales Contract or Appraisal
Start by reviewing the purchase agreement or an appraisal. These documents often specify the allocation between land and building. If reasonable and supported by evidence, this allocation is generally acceptable.
3.Use the Assessed Tax Values
When the sales contract or appraisal does not provide allocation details, many tax pros rely on local property tax assessments. Use the ratio of land to building values provided on the assessment and apply it to the purchase price. For example:
•If the tax assessment shows 30% land and 70% building, allocate the same ratio to the purchase price.
4.Fair Market Value (FMV) of Land and Building
If no other data is available or if the property tax assessment is inaccurate, consider obtaining an independent appraisal to determine the FMV of the land and building separately.
5.Ensure Consistency
Consistency is critical. Your allocation should be supportable and applied uniformly for tax purposes. This includes aligning the allocation method with similar properties your client owns.
6.Avoid Common Pitfalls
•Allocating too much to land can reduce your client’s depreciation deductions unnecessarily.
•Over-allocating to the building risks challenges from the IRS under IRC §482 (allocation of income and deductions).
7.Cite Supporting Authority
Case law, such as Alstores Realty Corp. v. Commissioner (46 T.C. 363), emphasizes the importance of using realistic and supportable methods for allocation. The IRS may challenge allocations that appear arbitrary or unsupported.

By allocating accurately and defensibly, you can help clients maximize their depreciation deductions while staying compliant with the tax code.

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