Calculating land and building values for tax purposes is an important step in optimizing the depreciation tax deductions. This is because the legislation only allows you to depreciate things that wear out over time (i.e., the building and not the land). 

Since most real estate purchasing agreements do not assign a value to each category, tax practitioners must be familiar with choosing the proper allocation of land and building.

A real estate valuation is often done for funding purposes, but it does not provide a land value. In these cases, where the purchase price is significant, it might be prudent to commission a land appraisal from the same appraiser. Any dollar transferred from land value to improvement value results in a permanent tax gain.

Non-depreciable assets (such as land) must be identified separately from taxpayers' depreciable building and site improvements. Taxpayers could consider the following options if a full-scope assessment demonstrating the land value was not completed during the purchase process:

1. Rely on the county tax assessor's allocation: A taxpayer can review their county tax assessor's property allocation, which usually provides an assessment of land and improvements based on the county's guidelines. This allocation can be found on the most recent property tax bill or the county assessor's website. The values listed may not match the total acquisition cost. The proportionate ratio between the land and improvement values can be applied to the final purchase price for income tax purposes. 

2. Commission a full-scope land appraisal: Another option is to commission a full-scope land appraisal. A qualified professional appraiser will generate a comprehensive analysis considering factors such as sales comparisons, highest and best use, market conditions, and income generated following Uniform Standards of Professional Appraisal Practice guidelines. While this option is the most accurate land valuation approach and least likely to be challenged by the IRS, it is also the costliest and can require several weeks to complete the process.

3. Limited-scope land appraisal: A limited-scope land appraisal can be completed by a real estate professional who analyzes sales comparisons or other limited metrics. Similar to a broker's opinion of value, this analysis is less detailed and may not follow USPAP guidelines.

Some taxpayers have successfully applied an average of the building and land allocation percentages to a newly acquired property if a client owns several properties identical to the one in question in the same geographic area with proven land values.

When land and buildings are purchased for one price, tax preparers must advise their clients on the pros and cons of using various approaches to allocating the cost for tax depreciation purposes. Relying on a property tax assessment for this information may result in leaving deductions on the table.

If the county tax assessor's land value is too high, looking at other options will result in substantial long-term tax savings, which a cost segregation analysis can intensify.