How do I split basis between land and building on the replacement property?

The regulation allocates by value at acquisition, and the IRS accepts assessor ratios as a fallback

Reg. section 1.167(a)-5 says that when buildings and land are acquired for a lump sum, the depreciable basis 'cannot exceed an amount which bears the same proportion to the lump sum as the value of the depreciable property at the time of acquisition bears to the value of the entire property at that time.' The ratio is fixed on the day you acquire, not when you file or when you sell.

Publication 527 turns that into practice: 'If you aren't certain of the FMVs of the land and the buildings, you can divide the cost between them based on their assessed values for real estate tax purposes.' Its example allocates 85% of a $200,000 purchase to the house because the tax assessment put $136,000 of a $160,000 assessed value on the improvements.

An appraisal that values land separately is the other common source, and it is the better one when the assessor's figures are stale or the land component is unusual. Whichever you use, use it once, keep it, and apply it consistently.

In an exchange the ratio is applied to your carried basis, which is lower than the price you paid

Your replacement's basis is not its cost. Section 1031(d) carries over the basis of the property you sold, adjusted for money, debt and recognized gain, and Form 8824 reports the result on line 25. How that figure is built is on basis in the replacement property.

Publication 551 then splits the real estate basis into two layers: 'The carryover basis is the adjusted basis of the property given up, and the excess basis is the remainder of the basis.' Each layer is multiplied by each asset's share of total fair market value, so land and building each get a slice of both.

The Form 8824 instructions also ask you to allocate line 25 among section 1250 property (line 25a), section 1245 property (line 25b) and intangible property (line 25c). A cost segregation study refines that split inside the building; whether it pays on a replacement is covered in cost segregation on the replacement.

Worked example: a $600,000 basis with a 25% land ratio leaves $450,000 to depreciate

Hypothetical, round numbers; run your own numbers with your CPA. You sold an unencumbered rental for $1,000,000 with an adjusted basis of $400,000 and bought a $1,200,000 replacement, adding $200,000 of your own cash. No boot, no debt, costs ignored. Your basis is $400,000 carried over plus $200,000 paid, so $600,000, of which $400,000 is carryover and $200,000 is excess.

The county assesses the replacement at 25% land and 75% improvements, and you have no better evidence of value. Land takes $100,000 of carryover basis and $50,000 of excess basis, $150,000 in total. The building takes $300,000 and $150,000, so $450,000 of depreciable basis.

Had you applied 75% to the $1,200,000 price instead, you would have claimed depreciation on $900,000, double the correct figure, and every year of overstated deductions would also reduce your basis for the later sale.

The building's two layers then follow two depreciation clocks unless you elect out

Reg. section 1.168(i)-6 keeps the exchanged basis on the remaining schedule of the property you sold and treats excess basis as placed in service when the replacement is. The mechanics, including what happens when residential and commercial lives differ, are on depreciating the replacement.

Paragraph (i)(1) lets you elect to treat the whole basis as newly placed in service. The election is made 'in the manner provided for on Form 4562' and 'must be made by the due date (including extensions)' of the return for the year of replacement. The land split comes first either way, because only the building portion enters either schedule.

Fix the allocation in writing before the first return, and keep it for the life of the chain

The land figure you choose now affects every depreciation deduction and the gain on every later sale or exchange. Save the assessor's notice for the acquisition year or the appraisal, a one-page allocation worksheet, and your Form 8824. The IRS tells you to keep records for exchanged property until the limitations period runs for the year you dispose of the new property; see tracking deferred gain across exchanges.

If the replacement is a Delaware Statutory Trust interest, Rev. Rul. 2004-86 treats you as owning an undivided fractional interest in the trust's real estate, so your share of land and building follows the trust's own allocation rather than a ratio you pick. Ask how the sponsor reports it before your CPA sets up the schedule; DST tax reporting covers the documents.