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July 12, 2018

Market Value of Land – Secrets of Cost Segregation Professionals

An often-hidden secret about many cost segregation professionals is that they are not involved in the real estate market place in terms of buying, selling, marketing or for that matter the valuation of real estate and are not qualified to provide an estimate of land value in reporting to the IRS. The lack of real estate expertise can result in a poorly prepared cost segregation study whose results are unreliable, undependable and could ultimately cost you money.

In the acquisition of real estate one of the first decisions that need to be made in terms of correctly reporting a real estate purchase for purposes of taxation is the estimate of the fair market value of land as this sets the basis for the remaining portion of the purchase price which is generally depreciable assets classified as section 1250 and 1245 property. It’s extremely important to note that this basic estimate affects the results and accuracy of any reported depreciable basis (generally speaking the entire cost segregation study results).

The IRS guidelines state that for acquired or used properties, “A quality study documents how the purchase price was allocated between land, land improvements, building and other assets. Land value is always determined first and is based on “highest and best use.” In simple terms, highest and best use means the probable use of land that result in its highest value. The balance of the purchase price is then allocated to the building and to other assets based on their value as of the date of purchase.”

Recently the U.S. Tax Court released Summary Opinion 2017-31 among the findings, the court rejected the tax payer’s allocations which were considered arbitrary. The tax court further concluded that the assessor’s allocation between land and improvements was more reliable.

With respect to this case, the tax payer appeared to be ill prepared and the reporting of the assets lacked the due diligence necessary to have a positive outcome under scrutiny of the tax court. It seems apparent that there was no meaningful thought or defendable estimate of the land value prepared by the tax payer.

As property values increase it seems likely that the IRS will continue to look closely at reported land values. At Kidder Mathews, we suggest that tax preparers and their clients strongly consider the qualifications of the cost segregation professional when it comes to appropriately establishing the value of the land. Reliance on opinions from non-qualified professionals should raise serious and immediate concerns. When the qualifications of the cost segregation professional are deficient, reach out to appraisers qualified to perform the due diligence necessary in appraising the land.

Proactively substantiating a value for the land with the appropriate due diligence will reduce your risk in comparison to rolling the dice on the likely hood of an audit and is a better alternative than simply using the tax assessor’s allocation which could wrongfully and inappropriately reduce your depreciable basis.

This article was written by Aaron Taylor, MAI of the Kidder Mathews Valuation Advisory Group.

For more information or for assistance with your valuation advisory needs, please contact:

Peter K. Shorett, MAI, CRE, FRICS
Executive Vice President
Kidder Mathews Valuation Advisory

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