Court Decision Favors Assessor Over Owner in Land vs. Building Valuation

The U.S. Tax Court recently ruled in support of the Los Angeles County Tax Assessor’s valuation of rental property improvements over the property owner’s proposed values.

In the case of Nielsen v. Commissioner, the court found that the county assessor provided a more reliable appraisal of land and improvement values than that of the owner’s own assessment. The court recognized that while a taxpayer is fit to provide a valuation of their entire property, a taxpayer is unqualified to offer the value of property between land and improvements. On May 8, 2017, Summary Opinion 2017-31 was released, outlining specifics of the court decision.

The main discrepancy in the court case was determining the tax depreciation values for the respective properties. Summary Opinion 2017-31 states that “if depreciable property and nondepreciable property such as real property with improvements are bought for a lump sum, the cost must be apportioned between the land and the improvements.” The court found that the petitioners included depreciation deductions on the rental properties based on the value of both the improvements and the land, thus incorrectly including nondepreciable land in their calculations.

In real estate transactions, separate building and land assessments are recommended, especially if the property is of significant worth. Many times, property is appraised for financing purposes but fails to recognize the importance of future tax benefits and implications by assessing the values of each piece of property and identifying the nondepreciable land from the depreciable improvements. If an assessment did not take place at the time of purchase, there are a few options available to taxpayers moving forward.

Taxpayers may consider the appraisal method used in Nielsen v. Commissioner and adopt the calculation provided by the county tax assessor, a value generated based on municipality guidelines. Another option is to contract a professional appraiser who follows the Uniform Standards of Professional Appraisal Practice guidelines. The professional will generate a report based on the scope of work needed to produce a complete analysis of the land and improvements valuation. The third option is to use a “rule of thumb” approach. While it is not the most official form of assessment, some taxpayers choose to use a predetermined allocation, for example 40%/60%, for land and improvements. Be advised the rule of thumb method may attract IRS inquiry.

A cost segregation study is also another opportunity for taxpayers to accelerate depreciation on qualifying assets, saving money and increasing cash flow. Visit BPW’s cost segregation page to identify qualifying properties and the benefits associated with the study.

Taxpayers are advised to consider appraisals on both land and improvements at the time of real estate transactions to ensure depreciable and nondepreciable property have been identified for income tax purposes. It is in the best interest of the taxpayer to obtain these valuations to claim potential deductions or avoid any unnecessary repayment.

If you have any questions on land and building assessments, cost segregation studies, or you are looking to receive general guidance on a real estate transaction, I’m happy to provide a tax perspective on your investments. Contact me at bforeman@bpw.com or (805) 963-7811.