Land Value in Real Estate: Why It Matters in Cost Segregation Studies

When it comes to investing in real estate and crafting a solid tax strategy, cost segregation stands out as one of the most effective ways to boost your depreciation deductions.

However, there’s a key aspect that often catches people off guard: land value isn’t included in these calculations.

Grasping how the IRS views land and knowing how to properly divide the value between land and building components is crucial for conducting accurate, audit-ready cost segregation studies. In this article, we’ll dive into what land value really means, why it plays such a vital role in cost segregation, and how to steer clear of common pitfalls that could end up costing you down the line.

What Is Land Value?

Land value is all about that portion of a property's purchase price that directly relates to the land itself, distinct from any buildings, enhancements, or personal belongings on it.

Take, for instance, a rental property you buy for $500,000. Not every penny can be depreciated. The IRS mandates that you separate the land's value from the value of any structures and improvements.

Why Land Value Matters in Cost Segregation

A cost segregation study aims to break down a property into its individual components (flooring, lighting, HVAC systems, etc.)to accelerate depreciation deductions.

Here’s the kicker: 👉 You can only depreciate the part of the purchase price that isn’t tied to the land.

That’s why getting the land value allocation spot on is so important. If you overestimate the building value, you might end up claiming depreciation on assets that the IRS doesn’t allow, which could raise a red flag during an audit.

On the flip side, if you underestimate it, you could be missing out on some valid deductions.

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IRS Guidelines & Regulations

According to IRS Publication 946, land is specifically excluded from depreciation.

“You cannot depreciate the cost of land because land does not wear out, become obsolete, or get used up.”

The IRS wants taxpayers to fairly divide the total purchase price between the land and the building using reasonable methods, such as:

• County tax assessor records

• Independent appraisals

• Property purchase documents that specify land/building allocations

• Replacement cost valuation methods

The IRS doesn’t require you to stick to just one method, but whatever you use must be supportable and consistent.

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Common Pitfalls to Avoid

Here are some of the most frequent mistakes investors make when handling land value in a cost segregation study:

Skipping Land Allocation Entirely

Some investors mistakenly apply depreciation to the full purchase price of a property, ignoring land value altogether. This inflates deductions and can trigger IRS scrutiny.

Using Unreasonable Allocations

Allocating 95% of a property’s value to the building and only 5% to land—without any supporting data—can appear aggressive and invite questions.

Using Inaccurate Tax Assessor Data

County tax records often understate market value or use outdated assessments. While useful, they shouldn't be the sole basis for land allocation unless verified against other sources.

Not Updating for Improvements

If you significantly renovate a property, the value of improvements may change the allocation between land and building. Failing to account for this in a new study could result in inaccurate depreciation.

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Best Practices for Handling Land Value

To ensure accurate, audit-ready cost segregation studies, follow these best practices:

• Obtain a detailed appraisal that includes a land/building value breakdown

  
  

• Use consistent allocation methods across multiple properties in your portfolio

  
  

• Document your rationale and sources for land value allocation

  
  

• Work with professionals (engineers, tax advisors, CPAs) who understand the nuances of land valuation in cost seg studies

Example: Land Allocation in Action

Let’s say you buy a multi-family property for $750,000. After reviewing the appraisal and assessor records, you determine that $150,000 is attributable to the land.

That means only $600,000 is available for depreciation. A cost segregation study might reclassify portions of that $600,000 into different years the property classes are eligible for accelerated or bonus depreciation.

Failing to subtract the $150,000 land value from the basis? You’re improperly depreciating land... and risking IRS penalties.

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The Bottom Line

Understanding land value is essential for effectively claiming depreciation deductions. The more precisely you divide your purchase price between the land and the building improvements, the larger your depreciable basis will be. This, in turn, opens up greater opportunities for accelerated deductions through a cost segregation study.

Getting the land vs. building split right ensures your tax benefits are:

✅ Maximized

✅ IRS-compliant

✅ Defensible in an audit

If you're feeling a bit lost on how to assess the land value or just want to confirm your allocation, it’s a smart move to reach out to a qualified cost segregation firm or a CPA who knows the ins and outs of real estate taxation. A small tweak today could lead to big savings down the line.

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