How to Allocate Land and Building Values
When you purchase a rental property, you’ll need to decide how much of your purchase price is allocated to the land cost and how much to the building (improvements) cost. Getting this allocation right matters. In this article, we’ll cover what it is, why it’s important, the resources you’ll need, the options for how to determine the split, and we’ll walk through a concrete example for a $1,000,000 property in 2025.
What is “allocating the purchase price between building and land”?
When you buy real property (land + improvements) the purchase price reflects the combined value of both the land and whatever buildings/improvements are on the land. But for accounting, tax, depreciation, purposes you often must split (“allocate”) the total purchase price into two separate categories:
The land component: The value of the land itself.
The building/improvements component: The value attributable to the structures, site improvements, building systems, etc.
Why do you have to do this? Because the land is non-depreciable (you cannot depreciate the land itself for tax purposes) whereas the building/improvements are depreciable.
So the allocation means: “Of the $X purchase price I paid, $Y is deemed to be land and $Z is deemed to be building/improvements, where Y + Z = X”.
Why it’s important to get it right
Here are several reasons why a correct (or at least supportable) allocation is important:
Tax implications & depreciation
If you allocate too much to land, you reduce the depreciable base of the building/improvements and thus reduce the annual depreciation deduction. If you allocate too little to land (i.e., too much to building), you risk a challenge by the IRS.Financial modeling/investment returns
When you build your pro-forma for an investment property you likely base cash flows, depreciation, and tax savings on the building value. Get the split wrong and your return estimates may be off.Disposition/sale/tax planning
When you sell or convert part of the property (e.g., land‐sale, building‐sale, or re‐zoning), the historic allocation will affect recapture, cost basis, etc.Audit risk & documentation
Tax authorities don’t like “magic numbers” with no support. Having a reasoned allocation—supported by appraisal, market evidence, or cost breakdown reduces the risk of objection.
Getting the allocation right means your tax basis, deductions, and stated values are defensible, reasonable, and aligned with reality.
Resources you will need
To perform a purchase price allocation, you’ll want to gather several pieces of information:
The purchase agreement documentation showing total price and what was included (land, building, fixtures, personal property, etc).
Tax assessor’s records (best approach): most jurisdictions list building value + land value for tax purposes. These can serve as a starting point (though often they lag the market, so you’ll use this with caution).
Your tax advisor to ensure the allocation is acceptable for depreciation and tax reporting.
Having these resources means you’re ready to establish and document a rational allocation rather than simply guessing.
Options for determining the allocation split
There’s no single “right” percentage that always applies (land/building splits vary hugely by market, property type, location, and age of building). Here are several methods you can use to arrive at a defensible split:
Using tax-assessed values (most defensible)
Most counties split assessed value into land and building components. You can use this ratio as a starting point (for example, if the assessor shows 30 % land and 70 % building).Comparable sales method
Look for comparable property sales of land alone (vacant land) and similar improved properties. From these, you can estimate what fraction of the value is land.Cost approach
Estimate what it would cost to replace the building/improvements new today (less depreciation) plus land cost.Rule of Thumb (least defensible)
Using a general 80/20 split is very easy and fast for tax filing purposes, but generally has no legitimate evidence for why this was used.
Example: $1,000,000 property in 2025
Let’s walk through a simple hypothetical to illustrate how you can allocate.
Scenario: You purchase a property in 2025. Purchase price = $1,000,000. The property includes land and a building (say a short-term rental).
Step 1 – Gather data:
Assessor’s record lists the property as: land value $300,000 / building value $450,000 (for a total assessed $750,000). That suggests 40% land (300/750) and 60% building (450/750).
Step 2 – Apply the split to the purchase price:
Purchase price = $1,000,000
Land portion (35%) = $1,000,000 × 0.35 = $350,000
Building/improvements portion (65%) = $1,000,000 × 0.65 = $650,000
Step 3 – Depreciation implication:
Assume the building qualifies for a 39-year nonresidential real property depreciation (straight line) beginning in 2025. Your depreciable basis is $650,000 (assuming no cost segregation study). So annual depreciation deduction $650,000/39 ≈ $16,667.
If you had instead allocated more to land (say 50%), then building = $500,000 → depreciation ~$12,821/year. The choice of allocation affects your annual tax deduction.
Summary & Practical tips
Whenever you purchase property of land + improvements, you need to allocate the purchase price between land and building.
Wrong allocation (too much to land, too little to building) can reduce tax benefits.
Review the building/land split with your tax advisor.
Use multiple methods, if you determine the tax assessor value seems inappropriate to arrive at a reasonable split rather than just guessing.
Document your assumptions and reasoning so you have a defensible position.
Remember: While the numbers matter, reason and documentation matter too. You want the allocation to hold up under IRS scrutiny.
Final thoughts
Allocating your purchase price between building and land might seem like a technical step tucked away in the closing or tax filing process, but doing it well is a sound business practice. It ties directly into how you recognize depreciation and evaluate returns.