From the Archives: Rental Properties and Basis Allocation

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It’s a holiday week so I’m re-posting popular blog posts from the past. This post from January 2013 deals with allocating basis in a rental property between the house and the land.

One common follow-up question on this topic is: what do you do if this has been done wrong? The answer is it depends on how long this has been an issue. Either you file amended tax returns or you file a Form 3115 to true-up the depreciation. I suppose one could also just choose to do nothing and carry on, though that’s not the right and proper thing.


Originally published January 16, 2013

One common mistake I see on tax returns involves rental properties. Specifically, the allocation of basis between the house and the land.

In almost all cases, people have allocated 100% of the purchase price toward the house, instead of allocating the purchase price between the house and the land.

For example, say you buy a rental house for $100,000. Part of the purchase price should be allocated to the house and will be depreciated over 27.5 years. Part of the purchase price should be allocated to the land and will be an asset but will NOT be depreciated.

How do you determine what the allocation should be? I usually use the property tax valuations. Those valuations seldom reflect the true market value of the property, but I use them to get the ratio. For example, if the county is allocating 75% of the assessed value of the property to the house and 25% to the land, I’ll use those percentages for allocating the purchase price.

This is the preferred method of the IRS (see pages 7-8 of the 2011 Publication 527). I have heard other accountants say they “always use 80% to the house and 20% to the land.” I disagree with the “always” part, but I suppose the 80/20 method is okay as long as it’s reasonable for the situation.