Split-Interest Land Acquisitions and Depreciation Deductions for Land

January 16, 2009 | Roger McEowen

 

Split-interest land acquisitions have some distinct tax-planning advantages.  If a corporation is used as one of the buyers, the technique can allow the removal of after-tax income from the corporation, and can result in a substantial part of the acquisition cost of the land to be allocated to the corporation without the land ending up as a corporate asset.  That latter point can be important if the corporation were ever to be liquidated.  In addition, the technique may provide a means for obtaining a depreciation deduction for the land.  That was the subject of recent IRS Private Letter Ruling.

Normally, land is not depreciable.  It doesn’t have a determinable useful life.  Buildings on the land are depreciable, but land is not.  But, there is a way to get a depreciation deduction for land.  The way to do it is to buy a term-of-years interest in land.  The IRS, in Private Letter Ruling 200852013 (Sept. 24, 2008), said that such a purchase converts the land into an intangible asset with limited use.  That’s what allows the land to be depreciated over the term of years.  Of course, the land must be used in the taxpayer’s trade or business or is held for the production of income.  If there are buildings on the land that is purchased as a term of years, the buildings are still depreciated using normal MACRS rules.    

So, if it’s that easy to get a deduction for land won’t there be an increase in the occurrence of jointly-acquired land – have a business entity buy a term interest and have a related family entity or person buy the remainder?  That way all of the land is acquired by the related taxpayers, but the family business gets the depreciation deduction.  Well, not so fast.  There are related party rules to worry about.  A related party is defined under I.R.C. §267(a) and (e) and includes the members of an individual’s family (brothers and sisters, spouse, ancestors and lineal descendants) as well as a corporation of which more than 50 percent of the stock is owned, directly or indirectly by family members.  If the related party rules are triggered, no depreciation deduction is allowed under I.R.C. §167(e) for the holder of the term of years when a related person owns the remainder.  The rules apply to term interests or life estates acquired after July 28, 1989.  If they are triggered, the term holder’s basis in the property is reduced every year by the depreciation which would have been allowable, and the remainder holder’s tax basis goes up every year by the same amount.  Another point to watch are split purchases between individuals.  Those types of purchases can trigger gift tax for the amount of the value of the term ownership gifted to the buyer of the remainder interest.  So, the split-purchase technique is basically confined to C corporations.  

Note:   To determine the amount of the purchase allocated to the term holder 
and the remainder holder, the IRS applicable federal rate must be used, 
along with the IRS actuarial tables.  The AFR is the 120 percent mid-term 
rate compounded annually, rounded to the nearest two tenths of one percent.  
That means that in low interest rate times, corporate share (the term interest) 
will be relatively smaller.

The split-interest purchase technique is an interesting one and, if done right, can lead to a depreciation deduction for the land.