Allocating purchase price between land and building

Why the split matters

Land does not wear out, so it is not depreciable. A building is. If you buy a rental property, an office or a small business location, the amount you can depreciate each year depends on how much of the price is attributed to the building. Publication 551 says to allocate when you buy buildings and the land on which they stand for a lump sum, so you can figure the depreciation allowable on the buildings. You also need the split to figure gain or loss when you later sell either piece.

The formula

The publication's method is a ratio. The basis of each asset is the lump sum multiplied by a fraction. The numerator is the fair market value of that asset and the denominator is the fair market value of the whole property at the time of purchase. Suppose a property cost $300,000 and an appraisal values the land at $60,000 and the building at $240,000. The land fraction is 60,000 over 300,000, which is 20 percent, so land basis is $60,000. The building is 80 percent, or $240,000. These numbers are an illustration; the publication gives the rule but no purchase-price example in this section. The calculator above applies the same ratio to up to three assets.

If the price differs from the total of the values, the ratio still works. A $330,000 purchase of that same property would allocate 20 percent, $66,000, to land and 80 percent, $264,000, to the building, because the fractions of fair market value are unchanged.

Where the values come from

The publication says that if you are not certain of the fair market values, you can allocate based on assessed values for real estate tax purposes. Assessments often show separate land and improvement figures on the tax bill. They can lag the market, but the ratio between land and improvements is often a defensible proxy. An appraisal, a purchase-price allocation in the contract, or a recent comparable sale of the land alone can give better support.

For a group of assets bought for a lump sum, the publication notes that you and the seller can agree on a specific allocation in the sales contract. If the allocation is based on the value of each asset and you and the seller have adverse tax interests, it will generally be accepted. For the purchase of a trade or business, a separate ordering rule allocates the price among asset classes, and both buyer and seller report the allocation on Form 8594.

Demolition and modification

If you tear down a building, the publication says to add the demolition costs and other losses on the demolition to the basis of the land, rather than claiming them as a current deduction. A modification is not treated as a demolition when both conditions hold: 75 percent or more of the existing external walls are retained in place as internal or external walls, and 75 percent or more of the existing internal structural framework is retained. If the building is a certified historic structure, the modification must also be part of a certified rehabilitation. When the conditions are met, the cost of the modification is added to the basis of the building.

Subdivided lots

If you buy a tract and subdivide it, you need a basis for each lot because you figure gain or loss on each sale. The method is the same ratio: total cost of the tract times the lot's fair market value over the entire tract's fair market value. You do not recover your full cost in the tract until you have sold all of the lots.

The publication's example: a tract is assigned a cost of $15,000 and divided into 15 equal lots, so each lot has a basis of $1,000. Later you determine the true basis was $22,500. Eight lots were sold using $8,000 of basis in years closed by the statute of limitations, which is generally three tax years. You can take $1,500 of basis for each of the remaining seven lots ($22,500 divided by 15) but cannot reopen the closed years. The calculator handles up to three assets, but dividing $22,500 by 15 gives the same $1,500 per lot.

Limits of this page

The page covers the arithmetic only. It does not tell you what the fair market values are, which depends on an appraisal or local assessment. It does not cover the more detailed class-by-class order for an acquired business, the Form 8594 reporting, or depreciation conventions. Related rules for developers who sell lots before improvements are finished require IRS consent under a revenue procedure that Publication 551 cites.

Sources

• IRS Publication 551, Basis of Assets (12/2025): Allocating the Basis, Group of Assets Acquired, Trade or Business Acquired, Land and Buildings (Demolition of building, Modification of building, Subdivided lots, Use of erroneous cost basis). Read November 2, 2026.

Edition read: Publication 551 (12/2025). The $300,000 and $330,000 figures above are our own illustration of the formula; the lot example is the publication's. This page summarizes the publication and does not replace it.