Tax Court Decision has Far-Reaching Impact on Depreciation of Real Estate by Angie Adames, CPA
Posted on June 26, 2017 by Angie Adames
Under Internal Revenue Code Section 167(a), taxpayers are permitted to claim a depreciation deduction for the exhaustion, wear and tear, and obsolescence of tangible property that is used in a trade or business or held for income production. The amount and determination of the deduction, which is limited to a “reasonable allowance” for the recovery of a taxpayer’s cost basis in the property (excluding land) over the property’s useful life, recently came under scrutiny by the Internal Revenue Service (IRS).
Generally, taxpayers bear the responsibility of proving depreciation deduction claims, which are determined by using the cost of the property as its basis, as well as the applicable depreciation method, the applicable convention, and the applicable recovery period. When taxpayers make a lump-sum purchase of improved real property and the underlying land, the value of non-depreciable land must be separated from the computation of the basis in the depreciable property. The higher the allocation of depreciable property, the higher the tax depreciation deduction allowable to the taxpayer.
In the matter of Nielsen v. Commissioner, the U.S. Tax Court rejected the taxpayers’ allocation of costs between depreciable and non-depreciable property and concluded that the allocations made by the IRS, based upon County tax assessments, were more reliable than the allocation methods suggested by the taxpayers. The Tax Court stated that while taxpayers are qualified to determine the value of the property they own, there is “no authority that suggests” taxpayers are suitable or eligible to allocate the value of property between land and depreciable property.
In light of this Court ruling, it is vital that property owners substantiate purchase price allocations in order to support the amount of tax depreciation they claim on their federal tax returns. To avoid any potential IRS challenges in the future, taxpayers should consider engaging a county property appraiser or similarly “reliable” professionals to independently assess the value of real estate property’s land separate from its depreciable property. Doing so will provide taxpayers with a more dependable purchase price allocation based on a property’s relative fair market value as well as long-lasting tax benefits.
The advisors and accountants with Berkowitz Pollack Brant work extensively with property developers, contractors, owners and investors to maximize their tax efficiencies, meet complex regulatory requirements and manage issues that require real estate litigation support.
About the Author: Angie Adames, CPA, is an associate director with Berkowitz Pollack Brant’s Tax Services practice, where she provides tax and consulting services to real estate companies, manufacturers and closely held business. She can be reached at the CPA firm’s Miami office at (305) 379-7000 or via email at email@example.com.