How to Allocate Land and Building Values

Land allocation is one of those decisions at the start of a real estate deal that compounds for the entire holding period. It rarely shows up on a closing checklist. The title company doesn't ask about it. The bank doesn't care. But the number you settle on, what portion of the purchase price is land versus building, drives every depreciation deduction you'll take for the entire holding period.

Get it wrong on the low side (too much land, not enough building) and you've given up tens of thousands of dollars of depreciation over the hold. Get it wrong on the high side (too little land, too much building) and you've built a position that doesn't hold up if the IRS asks how you got there.

Most clients don't think about this until their CPA pulls up the depreciation schedule in year one. By then the closing is done and they're stuck with whatever number gets recorded. It deserves more attention than that.

Why the Allocation Matters

Two reasons, in order of how much money is on the table:

Land is not depreciable. Land has no determinable useful life, so no depreciation deduction is allowed against it. The only piece of your purchase price that depreciates is what you allocate to the building and improvements.

The math is straightforward. On a $1M property, the difference between an 80/20 building-land split and a 60/40 split is $200K of depreciable basis. At 27.5-year residential depreciation, that's roughly $7,300 per year of depreciation you either get or don't get. Over a ten-year hold, $73K of deductions on the table. At a 32% marginal rate, $23K of federal tax savings, gone, just because the split was off.

Cost segregation amplifies the impact. If you're planning a cost seg study, the allocation between land and building determines the pool the engineer is working with. A higher building allocation means more dollars getting reclassified into 5, 7, and 15-year property, which means more bonus depreciation in year one. The number compounds.

Why People Get This Wrong

The default move in a lot of returns is the tax assessor ratio. The county assessor publishes a land value and a building value. The taxpayer or tax preparer applies the assessor's land-to-building ratio to the purchase price and moves on.

That's fine when the assessor's numbers reflect reality. The problem is that assessor values are sometimes stale, formula-driven, and bear no real relationship to current market values. In some counties the land-to-building ratio gets locked in at the original assessment and never updates as the building depreciates or the neighborhood appreciates. In others, the assessor is incentivized to push land high (it's not depreciable for the taxpayer, but it still generates property tax revenue).

I've seen assessor ratios put land at 40%+ on properties where the actual land value is closer to 15%. Accepting that ratio means accepting a smaller depreciable basis than you're actually entitled to.

The assessor ratio isn't wrong by default. It's just not the only option, and it's not always the best one.

The Methods That Actually Work

The IRS has never published a single mandated method for allocating purchase price. What it requires is that the allocation be reasonable and supportable. Several approaches qualify:

Tax assessor ratio. Easiest. Defensible when the assessor's numbers are reasonable. Pull the property's current assessment, calculate the land-to-building ratio, apply it to your purchase price.

Independent appraisal. Hire a licensed appraiser to value the land and improvements separately. Most expensive option, most defensible result. Worth it on larger acquisitions where the allocation difference is meaningful.

Cost approach. Estimate replacement cost of the building (new, less physical depreciation), then back into the land value as the residual.

Comparable vacant land sales. Find recent sales of comparable vacant land in the same submarket. Use those sales to establish a land value, then assign the rest of the purchase price to the building. Works well in markets where vacant land transacts regularly.

The 80/20 rule of thumb. Pick a percentage and run with it. It's fast, but one of the weakest position under examination. Defensible only if it happens to match the market and you can't know that without doing one of the analyses above.

In practice, most clients land on the assessor ratio or an independent appraisal, sometimes triangulating between two methods to pick the most defensible number. The exact method matters less than the documentation behind it.

Example: $1M Residential Rental Acquired in 2026

Take a residential rental purchased for $1M. Two ways the allocation could shake out:

Scenario A — Accepting the assessor's 40/60 split:

• Land: $1,000,000 × 40% = $400,000 (non-depreciable)

• Building: $1,000,000 × 60% = $600,000 (depreciable)

• Annual straight-line depreciation: $600,000 / 27.5 = $21,818

Scenario B — Independent appraisal supports a 20/80 split (more reflective of the actual land market in the submarket):

• Land: $1,000,000 × 20% = $200,000

• Building: $1,000,000 × 80% = $800,000

• Annual straight-line depreciation: $800,000 / 27.5 = $29,091

The annual difference is $7,273. Over a ten-year hold, that's $72,730 of additional depreciation. At a 32% marginal federal rate, roughly $23,300 of additional federal tax savings, purely from supporting a more accurate land allocation with proper documentation.

If you're also running a cost segregation study, the impact compounds. The cost seg engineer is working with the building basis. A larger building basis means a larger pool of dollars to reclassify into short-life property, which means a larger year-one bonus depreciation deduction.

A note on depreciation life: a 27.5-year life applies to residential rental property. Most short-term rentals fall into an exception under §168(e)(2)(A)(ii)(I) where transient lodging (average rental period of 30 days or less) can be treated as nonresidential 39-year property, typically when the activity is operated more like a hotel. The default for most STRs is 39 years.

What the IRS Looks For

If your allocation is challenged, the question isn't "did you get the perfect number." It's "did you have a reasonable basis for the number you used, and can you document it."

What that looks like in practice:

• A written record of the method you used and why

• The underlying data (assessor records, appraisal report, comparable sales analysis)

• Consistency between your tax return, your books, and any cost seg study you commissioned

• A defensible answer if asked why you didn't use the assessor's number, because that's usually the first thing the examiner reaches for

Reconstructing this five years later when an examination opens is painful and often unsuccessful. Set the file up at tax filing time.

Bottom Line

Land allocation is small in the moment and large over time. Most clients I work with default to whatever number happened to land on the original return. The ones who treat it as a real decision by pulling the assessor data, considering an appraisal on larger deals, documenting the method usually capture deductions that others give up.

I work with high-income earners across all 50 states who use real estate to reduce their tax burden. If you want to ensure you're getting as much depreciation as possible, I would love to help you.