Purchasers of improved real property to be used in a business or held for investment face an immediate issue in that the total purchase price paid for the property must be allocated between the land, which is not subject to a deduction for depreciation, and the improvement, which is depreciable property for income tax purposes. The amount allocated to each component must equal its fair market value. Taxpayers frequently base their allocation on the property tax bill for the property, which typically shows a value breakdown between land and improvement.
In the recent Tax Court case of Nielsen v. Commissioner (TC Summary Opinion 2017-31, 5/8/17), the taxpayer owned property in Los Angeles and claimed depreciation deductions on the full purchase price of the property which included the land as well as the buildings located on the property. The IRS found this error on audit and the case ended up in the Tax Court because the taxpayers and the IRS could not agree on how the price should be allocated between the land and the buildings. The IRS had based its adjustments on allocations obtained from the Los Angeles County Assessor. The Tax Court determined that the allocation from the Assessor was more reliable than any of the evidence presented by the taxpayer in supporting his theory.
Absent extenuating circumstances, the allocation on a property tax bill between land and improvements should provide a reasonable basis for determining the portion of the purchase price of a property upon which depreciation can be claimed, at least in Los Angeles County.