How to Allocate Your Land Purchase to Maximize Tax Savings?

Published on: 15:12PM Oct 17, 2010

We received the following questing regarding our post on the allocation of land purchase to vineyard AVA:

"Paul, You cover depreciating improvements on land. I am buying 150 acres in north-central Iowa that is bare ground. It has two county main tile lines running through it, has a blacktop road on one side and a gravel road on another. I am paying $705,000 for the farm. 15 acres are in CRP because they are wet. What percentage can you typically deduct for roads, tile, etc?"

When you purchase 150 acres of farm land, you are, as in this case, actually purchasing many components that need cost allocated to.  In this case, the farmer is buying:

  • 135 acres of productive farm land,
  • 15 acres of CRP,
  • Tile lines,
  • A gravel road, and
  • Probably some fencing.

To allocate this properly, you need to determine the reasonable fair market values of all of these items and then allocate the purchase price accordingly.  Fair market value for roads, tile line, fences should be based on what a reasonable third party would pay for the improvements, not the original cost.  For example, if it costs $700 per acre to put in the tile system and it is about 5 years old, you may want to assume a reasonable buyer would pay about $300-$500 per acre, not the $700 per acre of cost.

After determining all of these fair market values, you need to then allocate the purchase price based upon the percentage of fair market value for each item to the total fair market value times the actual purchase price.

Lets assume the following fair market values for each item:

  • 135 acres of productive land at $4,500 per acre or $607,500,
  • 15 acres of CRP at $2,000 per acre or $30,000,
  • Tile lines at $500 per acre or $67,500,
  • Gravel road of $20,000, and
  • Fencing of $15,000.

If you add all of these values together, you obtain a total fair market value of $740,000.  If we take each component and allocate purchase price based upon their related % to the total fair market value, we would get allocated purchase price as follows:

  • 135 acres of productive land  - $578,768,
  • 15 acres of CRP - $28,581,
  • Tile lines - $64,307,
  • Gravel road - $19,054, and
  • Fencing - $14,290.

If you add all of these values up, you get the purchase price of $705,000.  Since the tile, roads and fencing can be depreciated over 15 years, you have taken about $100,000 of the total purchase price and created a tax deduction versus treating all of the purchase as land.  In this case, that percentage would be about 15%, but every farm purchase will have their own unique situation.