Tax Court considers methods for allocating purchase price between land and improvements

Tax Hot Topics: Tax Court considers methods for allocating purchase price between land and improvementsIn Nielsen v. Commissioner, T.C. Summ. Op. 2017-31 (May 8, 2017), the Tax Court held that the IRS was allowed to rely on the local county assessor’s allocation of value between land and building improvements for depreciation purposes.

The taxpayers owned rental real estate properties and acquired two of the rental properties in 2003 and one in 2011. The taxpayers claimed depreciation deductions with respect to the rental properties by including both the cost of the building improvements and the land. The IRS disallowed portions of the depreciation deductions on the grounds that the taxpayers had incorrectly included the cost of the nondepreciable land in their calculations of depreciable basis for the rental properties. Although the taxpayers agreed that the land should not have been depreciated, they disagreed with the manner in which the IRS allocated the original basis between land and building improvements.

The IRS relied upon the Los Angeles County Office of the Assessor’s assessments to determine the allocations between the land and the improvements on the rental properties. The taxpayers raised various challenges to the accuracy and credibility of the IRS’s reliance on the county assessments and instead proposed two alternative methods of valuation: (1) land sales method and (2) insurance method. Additionally, the taxpayers had a professional appraisal performed on one of the rental properties in the year of acquisition. The county assessments the IRS relied on were from 2012 and 2013. As compared with the taxpayers’ professional appraisal, the county assessment allocated 4.4 % more to the taxpayers’ improvements than to the land.

The court found the allocations based on the county’s assessments more reliable and persuasive than the taxpayers’ methods.  The court noted that the professional appraisal and allocations obtained by the taxpayers on one of its properties supported the court’s finding.

Sharon Kay
Partner, Washington National Tax Office
T +1 202 861 4140

Ellen Martin
Partner, Washington National Tax Office
T +1 202 521 1558

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