Smart TaxesSmart Taxes

Who says you can't depreciate land?

Split it, put it in a trust, lease it, deduct it and create a legal tax break.

By Jeff Schnepper Mar 3, 2010 12:07PM

The IRS says you can’t depreciate land. Here’s how to do it….better.


Depreciation is the recovery of your cost from the purchase of an asset with a useful life of more than one year. If an asset, say office supplies, is expected to be used up within a year, you deduct the cost as an expense. But another asset, say a building, clearly has a useful life of many years. So, using prescribed IRS guidelines, you recover your cost by deducting a percentage of that cost over many years, technically the useful life.


The Tax Code doesn’t allow you to recover the cost of land. That’s because land has an unlimited useful life.


But, there’s another way to recover that cost.


Say you bought a rental property for $120,000 with $20,000 allocated to the land. The rules say you depreciate the building over 27.5 years (39 years for non-residential rental) and get no deduction for the land.


But, we don’t care about no stinkin’ rules!


Bifurcate the property. You can separate the property into land and building. Deed the land only into a trust you set up. Use an independent trustee, who could be your lawyer, accountant or financial advisor, and make your children the beneficiaries of the trust.


You now own a rental property on land that doesn’t belong to you. Your options are limited to moving the building or paying a lease rental.


Since it’s a rental property, that lease rental is now deductible. Say a fair market rental would be $1,000 a month. It would be hard for the IRS to argue valuation when the only other option would be moving the building.


In three years, you’ve recovered $36,000 in deductions for land that cost you only $20,000. The best part? These deductions don’t reduce your basis when you want to sell.


The cash you pay is deductible in your higher marginal tax bracket and taxable to your kids at their lower brackets. The spread is tax-free profit in your pockets.


If you’re in the 25% bracket and your kids in the 10% bracket, that’s 15% on $36,000, or $5,400 in just three years. Your tax savings will probably be greater because much of what’s paid to your kids may be tax-sheltered by their standard deduction.


If you have farmland that you’re working, put some acres into the trust and lease them back.


You’ll have to file a Gift Tax return, Form 709, for the transfer of the land into a trust. But, you’ll have an annual exclusion of $13,000 per child PLUS a lifetime exclusion of $1 million.


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