Is Land a Depreciable Asset for Tax Purposes?

Depreciation is an accounting method allowing for the recovery of the cost of an asset over time as it is used to generate income. This annual income tax deduction accounts for the wear, tear, and obsolescence that gradually reduces an asset’s value. Property owners frequently question whether land, a significant component of most real estate investments, can be treated this way for tax purposes.

The Nondepreciable Nature of Land

For tax and accounting purposes, land is not a depreciable asset. The Internal Revenue Service (IRS) prohibits the depreciation of land because it is not considered to have a determinable useful life. To be depreciable, property must be owned, used in an income-producing activity, last more than one year, and have a determinable useful life. Since land is not expected to wear out or become obsolete, it fails this final test.

The cost of land is a capital expenditure that is not recovered until the property is sold. At the time of sale, the original cost of the land is used to calculate the capital gain or loss on the transaction. This treatment contrasts with depreciable assets, where the cost is gradually deducted from income over many years, reducing an owner’s annual tax liability.

Depreciable Land Improvements

While the land itself cannot be depreciated, certain man-made additions to the land are depreciable. These are known as land improvements and are treated separately because, unlike land, they have a finite useful life and are subject to wear and tear.

Common examples of depreciable land improvements include:

• Paving for parking lots and driveways
• Fences
• Sidewalks
• Drainage systems
• Certain types of landscaping

For an improvement to be depreciable, its cost must be closely associated with other depreciable property. For instance, landscaping costs for bushes and trees planted next to a new business building may be depreciable because their life is tied to the building.

These improvements are depreciated over a 15-year recovery period under the Modified Accelerated Cost Recovery System (MACRS). Taxpayers can also use accelerated depreciation methods, such as the special depreciation allowance, for qualified improvements. For 2024, the bonus depreciation rate is 60%, allowing a significant portion of the cost to be deducted in the first year. This rate is scheduled to decrease annually until it is eliminated in 2027.

Allocating Property Costs

When real estate is purchased for a single price, the buyer must allocate the cost between the land and the building. This separation is necessary because the building is depreciable, and the portion of the cost assigned to it establishes its basis for depreciation. The depreciation period is 27.5 years for residential rental properties and 39 years for commercial properties.

A common method for this allocation is to use the relative values from the local property tax assessor, which provide separate values for the land and the building. The purchase price is then allocated proportionally based on these assessed values. For example, if an assessor values the land at $60,000 and the building at $240,000, then 20% of the purchase price would be allocated to the land and 80% to the building.

Another reliable method is to obtain a professional real estate appraisal. An independent appraiser can provide a detailed report that assigns specific values to the land, the building, and any land improvements. This allocation is documented on IRS Form 4562, Depreciation and Amortization, which is filed with the owner’s tax return. This proper allocation is needed to accurately calculate annual depreciation and determine the gain or loss when the property is sold.