by Austin BrownJuly 31, 2023

Understanding Land Value’s Impact on Cost Segregation Studies

While cost segregation studies are primarily concerned with depreciable assets, one non-depreciable asset plays a critical role in the study: land. In fact, the IRS’s most recent audit technique says the first step in a quality purchase price allocation cost segregation study is determining land value. 


A purchase price allocation study must reconcile to the full purchase price of a property, and a quality study documents how the purchase price is allocated between land, land improvements, building, and personal property. Using an incorrect land value will directly affect the taxpayer’s overall depreciable basis in the property and create inaccuracies throughout the rest of the study.


These inaccuracies can increase audit exposure and cause the taxpayer to overstate their depreciation adjustments. Taxpayers can expect increased scrutiny of land value by the IRS in the coming months and years, so let’s look at the correct methods you can use to determine the value of your property’s land.


According to Publication 551, the IRS accepts two methods in establishing a land value: fair market value and pro rata land allocation to total value via the local assessor’s office. Fair market values can be found via land appraisal. The fair market value should be based on the highest and best use of the land. Appropriate appraisal practices and procedures must be applied when establishing a fair market value of the land. These types of procedures and practices are preferred to be done by a licensed appraiser. 


Fair market value land values are considered the best option, however, pro rata allocations are acceptable when there is no fair market value available. Pro rata allocations use information readily available on the taxpayer’s local property assessor’s website. By taking the ratio of land to total value on the assessor’s website, we can apply the percentage to the new purchase price to determine land value. 


The U.S. Tax Court recently upheld this practice in the 2017 hearing of Nielsen v. Commissioner. Despite the petitioner’s accuracy and credibility challenges to the assessor’s land valuations, the court sided with the assessor’s valuation describing it as “more reliable and persuasive.” Taxpayers commonly make the error of simply using the assessor’s land value as their own, which does not account for the actual purchase price of the property. This will cause the taxpayer to overstate their depreciable basis and claim inaccurate depreciation deductions.


Most taxpayers don’t associate land value with cost segregation studies; however, it is necessary for any purchase price allocation. Land value analysis has become a point of emphasis for auditors, and the IRS has stressed this in repeated audit technique guides. By using the IRS’s preferred methods of establishing land value, taxpayers can confidently determine their property’s depreciable basis and begin properly taking advantage of depreciation deductions. 


The fixed asset consultants at McGuire Sponsel are available to guide taxpayers through this process so they can confidently take advantage of depreciation deductions. 

Austin Brown is a manager for the Fixed Asset Services practice. He leads the Fixed Assets practice improvement/development team and efficiently manages our Cost Segregation study project workflow.

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