However, he can use the same percentages as determined by the assessor and apply them to the original purchase price to determine how much can be depreciated. In this example, Ryan's purchase price was different than the assessed value. Ryan bought an office building for $100,000. The IRS also offers the following example: If we continue on this path of using the local assessor's opinion of the property's land value, we can use their percentages to come up with the right depreciable amount. Using the Assessor's Opinion of Land Value While the IRS doesn't explicitly state that the tax assessor's opinion of land value is the only option that can be used, based on this statement, the IRS seems to prefer this approach. You can use the property tax assessor's values to compute a ratio of the value of the land to the building.” “Since land cannot be depreciated, you need to allocate the original purchase price between land and building. Since this entire calculation is subject to the IRS's judgment, it's helpful to hear their input on how to do this: – acquisition price), the next step is to identify what portion of that number is attributable to the land. Once we've established the baseline value (i.e. With that said, the issue of calculating the land value specifically (as opposed to the value of the buliding, land improvements or equipment) is another matter that needs to be evaluated separately. – the purchase price) and not what the value might be. When it comes to calculating eligible costs for depreciation, the baseline value always starts with what you PAID for the property (i.e. Since this is literally the price that was paid for the property, this could also be a reasonable number to use when determining the market value of the property and, ultimately, the depreciation amount. The assessor can use this data point, along with comparable property sales in the area to determine what the most realistic value of the property is. Assessed ValueĮvery time a piece of real estate is bought and sold, the sale is reported to the local assessor so they know the change of ownership and the price paid for the property. Appraisers will typically use the income approach, the sales comparison approach, and/or the cost approach to determine the most realistic value of a property. When most properties are bought and sold, an appraisal is performed by a professional appraiser.Īn appraisal is an unbiased assessment of a property's value, accompanied by supporting data to support the validity of the valuation. In the real estate industry, there are different ways to determine what a property may be worth, here are a few of the most common methods… Appraised Value RELATED: Finding the Right Accountant for Your Real Estate Business How to Establish Property ValueĪs mentioned above, this process starts with establishing an appropriate value for the subject property… but when we're talking about real estate, “value” can be very subjective. Depreciation Timeline: How quickly can the value of the building, land improvements and equipment be depreciated and written off?ĭoing this correctly will allow the property owner to save significant tax dollars each year (and when the property is eventually sold).ĭoing this incorrectly will result in unnecessary tax expenses or penalties, so it's important to get this right!.Land Value: What portion of the property's value is attributable to land rather than the building?.Property Value: What is the appropriate number to use for the property's beginning value?.Likewise, certain types of buildings and equipment will wear out faster than others, so to calculate this number correctly, it's important to understand a few key things: How Much Can Be Depreciated Each Year?Ī building can be depreciated, but land cannot (i.e., buildings and equipment will eventually wear out and need to be replaced, but dirt doesn't). This ultimately means the real estate investor gets to keep more money and pay less to the government each year. It's a paper loss that reduces the investor's taxable income and effectively reduces their annual tax obligation, even if there are no direct capital expenditures for the property in that tax year. The word “phantom” is often used because this expense doesn't have a tangible negative impact on the property owner's bank account. Perhaps the most notable tax advantage is the ability to write off the cost of depreciation.ĭepreciation is a “phantom expense” that the IRS allows real estate investors to deduct from their taxable income each year to account for the natural wear-and-tear that occurs to the physical improvements of a property. Owning real estate offers many significant tax advantages that other investments don’t.
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