Cost allocation of land

[Jesse]

A similar question came up on the QF board and I'd be curious to other opinions.

A forty was purchased and split into 4 ten acre parcels, w/only one having lake frontage and worth more than the other 3 parcels put together.

After the purchase of the forty we had an appraisal done and gathered other comparable RE sales to show the differences in value of the 4 parcels. As each of these parcels sell we want to determine the purchase price for each of these parcels based on the FMV allocation.

Client paid $185,000 for forty and based on the FMV allocation we determined the cost of the lake front parcel to be $125,000 and the other three at $20,000 each. There is an offer to purchase on the lake front parcel for $200,000 and I want to use the $125,000 basis rather than a per acre allocation of $46,250.

Do you see problems with this?

[Bees Knees]

I would say what you propose is correct. There is a similar principle mentioned in IRS Pub. 225, page 22 under “allocation of taxes.” It says:

“The taxes on the part of your farm you use as your home (including the furnishings and surrounding land not used for farming) are nonbusiness taxes. You may be able to deduct these nonbusiness taxes as itemized deductions on Schedule A (Form 1040). To determine the nonbusiness part, allocate the taxes between the farm assets and nonbusiness assets. The allocation can be done from the assessed valuations. If your tax statement does not show the assessed valuations, you can usually get them from the tax assessor.”

This same principle ought to apply to the sale of the same land. If you are determining the business portion of expenses based upon assessed value (or FMV) rather than acreage, then it should also be reasonable to allocate basis for purposes of determining the business portion of the gain vs. the nonbusiness portion of the gain by using the assessed value rather than acreage. So if business vs. nonbusiness use basis can be allocated this way, so should dividing up basis on land that has been divided into lots.

[Bees Knees]

I did a quick search and found that my previous opinion is supported by Reg. Sec. 1.61-6(a) which gives an example that shows you allocate basis based on the FMV of each portion of the property at the time of purchase.

[ED SMITH]

Allocation

I did a quick search and found that my previous opinion is supported by Reg. Sec. 1.61-6(a) which gives an example that shows you allocate basis based on the FMV of each portion of the property at the time of purchase.

I agree with the examples given in your previous answer. As I understand it, the purchase was made of raw, unimproved land. There was no allocation of cost at the time of purchase. Does the cited reg still hold in this case?

ED

[Jesse]

J.K. Lasser's

I did find this in J.K. Lasser's Your Income Tax 2005 Book:

Allocating Cost Among Several Assets – Purchase of land to be divided into lots: The purchase price of the tract is allocated to each lot, so that the gain or loss from the sale of each lot may be reported in the year of its sale. Allocation is not made ratably, that is, with an equal share to each lot or parcel. It is based on the relative value of each piece of property. Comparable sales, competent appraisals, or assessed values may be used as guides.

[Bees Knees]

I agree with the examples given in your previous answer. As I understand it, the purchase was made of raw, unimproved land. There was no allocation of cost at the time of purchase. Does the cited reg still hold in this case?

ED

It is true that the allocation in the cited reg examples applies to the FMV at the time of purchase, not the time of sale. If no appraisal was done at the time of purchase, you would have to make a reasonable estimate.

But I’m not sure I would rule out allocating FMV of basis after improvements were made. In my original post on IRS Pub 225, allocation of expenses applies to the current year assessed value, not the value at the time the property was purchased.