What if I told you that you could buy an asset that would never lose value? You would be pretty excited, right? Outside of Treasury bonds, very few investments are guaranteed to never lose value. The fact that land doesn’t depreciate does not mean it may not potentially lose value. It does however mean that the IRS will never consider it an asset you can use on your tax forms the same way you can deduct a tractor, a combine, or a car.
When you buy land you have to prepare to make the right decisions to protect your investment, and by following the IRS guidelines on land purchases, you can get top value out of your land as a solid investment without running afoul of any tax laws.
Why doesn’t land depreciate?
The IRS offers several terms for depreciation, and there is a crucial reason why land never depreciates. According to the IRS:
Land can never be depreciated. Since land cannot be depreciated, you need to allocate the original purchase price between land and building. You can use the property tax assessor’s values to compute a ratio of the value of the land to the building.
The IRS does not allow the depreciation of land simply because the value of the land is almost impossible to devalue. In any given year, the land could be the site of construction, a new home or building could be placed there, or it could be worked for income generation, just to name a few of the possibilities.
Therefore when it comes to purchasing land, the IRS views land and improvements as completely separate line items. When you look at your tax assessor’s form for property, you can multiply the assessment by 25% to receive your IRS equivalent land value. The remaining 75% of the assessment will be considered as improvements to the land.
What does depreciate?
Depending on the kind of improvements, you may or may not have the ability to depreciate some of the cost put in to improve the land. Should the improvements be a building or a home, it is rare that you will ever qualify for depreciation, though you are likely to receive a deduction for your mortgage interest. You will need to contact a certified public accountant for more details.
In the case of land, many of the land-based improvements that can be subject to depreciation include: fencing, sidewalks and walkways, parking lots, roads, bridges, grading/erosion control, and improved lighting are all items that can be depreciated as they have a limited lifetime.
Making solid decisions and planning for your future
Understanding the value of your land and improvements can help you make good decisions and maximize the value of your land. Common improvements in development pressure zones include adding fencing, utilities, and blacktop driveways. The addition of a utility service like power or sewer lines can be a significant improvement to the quality of your land. The rural communities’ common improvements can be a septic system or well.
We have to understand that everyone has a different definition of rural communities. Rural communities can have grades of access, there is simply no one size fits all. You can live 35 minutes from a major metropolitan area and still be considered rural under your state’s definition. There are farms within an hour of major cities in America. Some advice that works in one rural area may be successful, but in another area, it might not be successful – because not all rural areas are the same. The communities in the rural areas have the strongest voice as to what they consider improvements. Consult your tax professional and land agent for what depreciates and what sells.
Unlike houses, the curb appeal of land is addressed by available services and the quality and upkeep of the property, including brush removal and the elimination of debris. First-time land buyers will be looking for improvements that make your land more attractive. When your land is attractive to these buyers, it is much easier for them to see a 25/75 split toward their construction cost. If a land buyer sees your property without improvements, they will be calculating the improvement cost into their side of the 25/75 assessment split, which may automatically price out many potential buyers. Preventing buyers from being deterred by thinking your land puts them behind on building their project gives you a larger pool of potential buyers for the property you’re selling.
While these are early expenses, increasing return value by making the land more attractive to buyers is often the most important benefit you can receive. As a landowner, you can benefit from these expenses while improving your property. The IRS offers instructions as to deduction-ready improvements and accountants offer their own assessment of how land owners can qualify.
Land is only getting more valuable, best to buy now while you can!