Dear Tax Talk,
I am purchasing a condo for rental income purposes. Can I use the total value for depreciation due to the fact that, for real estate tax purposes, no value is placed on the land?
— Steve

Dear Steve,
Depreciation is a tax deduction that allows you to recover the cost of income-producing property. While it is usually the case, except until recently, that real property appreciates, the depreciation deduction is meant as a tax benefit to recover the cost of your investment.

Although you later recover the tax deduction when you sell at a gain, the tax rate applied to the accumulated depreciation is usually favorable. 

Requirements for depreciating your property:
  • You own the property.
  • You use the property in your business or as a rental activity.
  • The property has a determinable, useful life.
  • The property is expected to last more than one year.

You can depreciate the improvements to land, such as the building. You cannot depreciate the cost of land because land generally does not wear out, become obsolete or get used up.

If you buy buildings and your cost includes the cost of the land on which they stand, you must divide the cost between the land and the buildings to figure the basis for depreciation of the buildings. The part of the cost that you allocate to each asset is the ratio of the fair market value of that asset to the fair market value of the whole property at the time you buy it.

IRS Publication 527 states that “if you are not certain of the fair market values of the land and the buildings, you can divide the cost between them based on their assessed values for real estate tax purposes.” In your case, the tax assessor did not make an allocation, but presumably the land under the condo is owned.

In this case, I would still recommend that you allocate a portion of your cost to the land to show good faith compliance with the rules. If you allocated 10 percent or so of the total cost to the land, then it becomes the IRS’ burden to show differently.

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To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.

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