Most real estate transactions involve land and improvement components. If such property is used in a trade or business, or if the property is held for producing income, the IRS allows for a depreciation deduction to account for a reasonable allowance of exhaustion, wear, and tear.
However, land itself doesn’t depreciate, considering that it doesn’t wear out, become obsolete, or get depleted. Therefore, the taxpayer must allocate the purchase price between non-depreciable land and depreciable property.
Since most real estate transactions and purchase agreements don’t always assign value to these components, the taxpayer should understand the options available to them in determining a reasonable allocation to both depreciable and non-depreciable property.
More importantly, a taxpayer should understand that the burden of proof in self-allocating value to land will fall on the taxpayer if they’re ever audited. Taxpayers must be objective.