Purchase price allocation for real estate divides the cost of a property bought for one price between the land, which is not depreciable, and the building and its components, in proportion to their fair market values at acquisition (Treas. Reg. §1.167(a)-5); a cost segregation study then splits the building share into 5-, 7-, 15- and 27.5- or 39-year property.
Two different exercises share the name. In mergers and acquisitions, a purchase price allocation (PPA) under ASC 805 assigns the price of a business combination to identifiable assets and goodwill for the financial statements. This article is about the tax allocation a real estate buyer and the buyer’s CPA make for depreciation: it decides how much of the price can be depreciated at all, and it is the starting number every cost segregation study reconciles to.
What Is Purchase Price Allocation for Real Estate?
Purchase price allocation for real estate is the step that turns one cost basis into separate bases for the land and the depreciable property, because the basis of property is its cost under IRC §1012 and depreciation applies only to the part of that cost that wears out. Treas. Reg. §1.167(a)-2 says the depreciation allowance does not apply “to land apart from the improvements or physical development added to it”, and IRS Publication 527 puts it plainly for rental owners: “You can’t depreciate the cost of land.”
The cost being divided is more than the contract price. IRS Publication 551 says basis includes the settlement fees and closing costs for buying property, and lists items such as abstract fees, legal fees for the title search and the contract and deed, recording fees, surveys, transfer taxes, owner’s title insurance and amounts the seller owed that the buyer agreed to pay. The closing (settlement) statement is therefore the first document a cost segregation study starts from.
For a lump-sum purchase of land and buildings, Treas. Reg. §1.167(a)-5 limits the basis for depreciation to the share of the lump sum that the value of the depreciable property bears to the value of the whole property at the time of acquisition. Publications 527 and 551 state the same rule as a fraction, the fair market value of the asset over the fair market value of the whole property at the time of purchase, and both add that a buyer who is not certain of those values can divide the cost using the assessed values for real estate tax purposes.
How Is the Land and Building Split Determined in a Real Estate Purchase?
The land and building split is determined from fair market values at the purchase date, and the evidence for those values is what separates a supported allocation from a guess: an appraisal that values the land at its highest and best use as though vacant, the county assessor’s land-to-improvement ratio, or an allocation the buyer and seller agreed in the purchase agreement.
- An appraisal. The IRS Cost Segregation Audit Techniques Guide (Publication 5653) says the fair market value of land “should be based on the highest and best use of the land as though vacant, even if the land has improvements”, and that values should be developed under professional appraisal standards, typically USPAP.
- The assessor’s ratio. Publications 527 and 551 allow assessed values when the buyer is not certain of the fair market values. The same guide tells the IRS to be wary of a cost segregation study that relies solely on local assessed values rather than determining fair market values, so a ratio is stronger with the assessor record for the year of purchase behind it.
- The purchase agreement. Publication 551 says that when the buyer and seller agree an allocation in the sales contract, based on the value of each asset, and they have adverse tax interests, the allocation will generally be accepted. When the purchase is a trade or business under §1060, a written allocation can do more than that, as the next two sections explain.
One method is ruled out: the guide calls it inappropriate to estimate the land’s value by subtracting the estimated value of the improvements from the price, because land assigned as a residual may be understated and the depreciable improvements overstated. A fixed rule-of-thumb ratio, such as 80 percent building and 20 percent land, is a placeholder, not a measurement of this property’s land, until one of these methods replaces it. The methods, their limits and the documents behind each are set out, for an Opportunity Zone building, in the Opportunity Zone substantial-improvement test and cost segregation.
A hypothetical example. A buyer pays $2,000,000 for a rental building and $40,000 of settlement costs that are added to basis, so the lump sum to divide is $2,040,000. If an appraisal values the land at $500,000 of a $2,000,000 whole, the land’s share is 25 percent: $510,000 of land and $1,530,000 of building and improvements. If the assessor’s record instead showed 35 percent land, the same purchase would carry $714,000 of land and $1,326,000 of depreciable basis, $204,000 less for the cost segregation study to reclassify and for depreciation to recover. The figures are illustrative arithmetic, not values for any property.
When Do §1060 and Form 8594 Apply to a Real Estate Purchase?
Section 1060 and Form 8594 apply to a real estate purchase only when it is an applicable asset acquisition: a transfer of a group of assets that constitutes a trade or business in the hands of the seller or the buyer, where the buyer’s basis is determined wholly by the consideration paid (IRC §1060(c); Treas. Reg. §1.1060-1(b)(1)). Under Treas. Reg. §1.1060-1(b)(2), a group of assets is a trade or business if its use would constitute an active trade or business under §355, or if goodwill or going concern value could under any circumstances attach to it. An operating business sold together with its building, such as a hotel bought as a going business, is the typical case; whether a particular rental property meets the test turns on its facts, and that determination belongs to the buyer’s tax advisor.
In an applicable asset acquisition, the buyer and the seller each allocate the consideration by the residual method of Treas. Reg. §§1.338-6 and 1.338-7 (Treas. Reg. §1.1060-1(c)(2)). The consideration is allocated through seven asset classes in order: cash and deposit accounts (Class I), actively traded personal property such as securities (Class II), receivables and assets marked to market (Class III), inventory (Class IV), all other assets (Class V), section 197 intangibles other than goodwill (Class VI), and goodwill and going concern value (Class VII). The Instructions for Form 8594 place buildings, land, furniture, fixtures and equipment that make up a trade or business in Class V, which takes its share in proportion to fair market values and never more than an asset’s fair market value (Treas. Reg. §1.338-6(b)(2) and (c)(1)); whatever is left goes to goodwill and going concern value.
Both parties then report the allocation on Form 8594 (Asset Acquisition Statement Under Section 1060), attached to their income tax returns for the year that includes the first date assets are sold, and file a supplemental Form 8594 when the consideration changes in a later year (Treas. Reg. §1.1060-1(e)(1)(ii)). The instructions list exceptions, including assets exchanged for like-kind property in a transaction to which §1031 applies (Form 8594 is still required for any part of the assets to which §1031 does not apply). A purchase of a building that is not an applicable asset acquisition has no Form 8594; it is allocated under Treas. Reg. §1.167(a)-5 as above.
Can a Written Allocation in the Purchase Agreement Block a Later Cost Segregation Study?
A written allocation can block a later cost segregation study when the purchase is an applicable asset acquisition under §1060 and the agreement allocates the price between personal and real property, because §1060(a) makes a written allocation, or a written fair market value, binding on both the buyer and the seller unless the IRS determines that it is not appropriate. Treas. Reg. §1.1060-1(c)(4) keeps the IRS’s right to challenge the allocation, while a party can escape it only with the kind of proof described in Commissioner v. Danielson, 378 F.2d 771 (3d Cir. 1967), such as mistake, undue influence, fraud or duress.
The Cost Segregation Audit Techniques Guide describes how that played out in Peco Foods, Inc. v. Commissioner, T.C. Memo. 2012-18, aff’d 522 Fed. Appx. 840 (11th Cir. 2013). The buyer acquired two poultry processing plants in applicable asset acquisitions with written allocation schedules, later commissioned a cost segregation study and filed Form 3115 to reclassify part of the buildings as personal property. The Tax Court held the buyer was bound by the clear and unambiguous terms of the schedules and could not change its method of accounting for those assets on the strength of the study. The guide adds two limits: it is unclear whether Peco Foods applies to acquisitions other than applicable asset acquisitions under §1060, and where there is no written allocation the study is reviewed on its own terms.
In an applicable asset acquisition, then, a schedule that allocates an amount to the building as a whole is the kind of allocation the IRS argued in Peco Foods could not later be subdivided into component assets, and the Tax Court held the buyer to its schedules.
How Does the Allocation Set Depreciation, Bonus Depreciation and Recapture?
The allocation sets depreciation because only the building and improvement share is recovered: residential rental property over 27.5 years and nonresidential real property over 39 years under IRC §168(c), unless a cost segregation study identifies parts of that share that are 5- or 7-year personal property or 15-year land improvements. The land share is never depreciated; it is recovered only through basis when the land is sold or otherwise disposed of.
The shorter-lived property a cost segregation study identifies can also qualify for bonus depreciation. Bonus depreciation under IRC §168(k) is 100%, permanently, for qualified property acquired after January 19, 2025 (OBBBA, 2025-07-04), or, for self-constructed property, whose construction began after that date; qualified property acquired on or before that date stays on the TCJA phase-down (as does self-constructed property begun on or before it) by placed-in-service year: 80% in 2023, 60% in 2024, 40% in 2025, 20% in 2026, and 0% after that, with each rate one year later for long-production-period property and certain aircraft (§168(k)(6)(B)). A building bought after someone else has used it is used property, and used property qualifies only if the taxpayer had not used it at any time before acquiring it and the acquisition meets the §179(d) purchase rules that §168(k)(2)(E)(ii) applies (for example, it was not acquired from a related party, by gift or inheritance, or with a carryover basis).
The same allocation sets how much of the basis was depreciable and, on a sale, how much of the amount realized falls on each class. On a taxable sale at a gain, recapture applies, up to the amount of that gain, however long the property was held, outside the Opportunity Zone 10-year rule (a qualifying investment held 10 years with the IRC §1400Z-2(c) election): §1245 recapture on the 5- and 7-year property is ordinary income, as is §1250 recapture of the depreciation taken above straight-line (bonus included) on 15-year land improvements held more than one year, and the rest of the depreciation on those land improvements and on the 27.5- or 39-year structure is unrecaptured §1250 gain, taxed at up to 25% for a noncorporate taxpayer. On the seller’s side, on a sale at a gain, §1245 recapture on the seller’s own 5- and 7-year property is ordinary income up to the depreciation taken on it, so it depends on how much of the amount realized is allocated to that property, which is one reason a seller who ran its own cost segregation study and a buyer planning one can want different allocations, and why Publication 551 ties acceptance of an agreed allocation to adverse tax interests.
Is Real Estate Purchase Price Allocation the Same as PPA Accounting Under ASC 805?
Real estate purchase price allocation for tax is not the same as PPA accounting under ASC 805, although both start from fair values. For financial statements, ASC 805-10-55-5A treats a set of assets as not a business when substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets, and ASC 805-10-55-5B counts land and the building attached to it, and in-place leases with the leased property, as a single identifiable asset. Many single-property purchases are therefore asset acquisitions for book purposes, with the cost allocated on a relative fair value basis and no goodwill, as Deloitte’s Business Combinations Roadmap (section 2.4) describes.
The book allocation can carry assets, such as in-place lease intangibles, whose tax treatment is decided separately, and the tax return follows the tax rules above, not the financial statements. A cost segregation study reconciles to the tax basis, which is why it starts from the closing statement and the tax fixed-asset records rather than the book PPA.
What Does an Opportunity Zone Purchase Add to the Allocation?
An Opportunity Zone purchase makes the same land and building split decide a second number: for an existing building a Qualified Opportunity Fund or its qualified opportunity zone business buys that has to be substantially improved (one that is not original-use property), substantial improvement is measured by additions to the basis of the building, as determined under §1012, not counting the land under it (Treas. Reg. §1.1400Z2(d)-2(b)(4)(iv)(A) and (E)). Under IRC §1400Z-2(d)(2)(D)(ii), the additions during any 30-month period after acquisition must exceed the building’s adjusted basis at the start of that period, or 50 percent of it for property in a qualified opportunity zone comprised entirely of a rural area.
For a given price, every dollar allocated to land lowers that improvement bar and is a dollar that cannot be depreciated, so the split follows the land’s fair market value at acquisition rather than whichever result either rule would favour. A cost segregation study does not lower the substantial-improvement threshold: it supports the documented split and classifies the improvements, and whether the test is met is a determination for the fund’s tax counsel. The fund-level mechanics, from the 30-month clock to recapture at exit, are in our guide to Opportunity Zone cost segregation.
What Does a Cost Segregation Study Need From the Purchase Price Allocation?
A cost segregation study needs the documents that prove the allocation: the closing statement for the total cost, the purchase agreement and any allocation schedule, and the appraisal or assessor record that supports the land value. A document-driven, human-reviewed ClickDrag Finance cost segregation study takes the land figure from the documents provided, such as the appraisal, assessor record, purchase agreement, closing statement or trial balance, states which source the figure came from, and reconciles land, building and component amounts back to the total cost, so the 5-, 7-, 15- and 27.5- or 39-year amounts add up to the basis the return carries.
A buyer can check whether a cost segregation study fits the property with the cost segregation qualifier. What a study is and how it works from start to finish is in what a cost segregation study is, and the files to gather are in the documents a cost segregation study needs. To compare providers before choosing one, see the best cost segregation companies, compared.
Frequently Asked Questions
What is purchase price allocation in real estate?
Purchase price allocation in real estate divides the cost of a property bought for one price, including the settlement costs added to basis, between the land and the depreciable building and improvements in proportion to their fair market values at acquisition (Treas. Reg. §1.167(a)-5). The building share is what depreciation recovers and what a cost segregation study reclassifies into shorter recovery periods.
Does depreciation apply to the land after a real estate purchase?
Depreciation does not apply to the land after a real estate purchase, because the allowance does not apply to land apart from the improvements added to it (Treas. Reg. §1.167(a)-2). Improvements to the land, such as paving and landscaping, are depreciable, and a cost segregation study typically classifies them as 15-year land improvements; the land itself is recovered only through basis when it is sold or otherwise disposed of.
Is Form 8594 required when buying a rental property?
Form 8594 is required when buying a rental property only if the purchase is an applicable asset acquisition under §1060, meaning the assets constitute a trade or business, such as an operating business sold with its building, and the buyer’s basis is determined wholly by the price paid. A purchase of a building that is not a trade or business is allocated between land and building under Treas. Reg. §1.167(a)-5 and needs no Form 8594.
Can a cost segregation study change the purchase price allocation in the contract?
A cost segregation study generally cannot change a written allocation between personal and real property in an applicable asset acquisition under §1060, because §1060(a) binds both parties to it unless the IRS determines it is not appropriate, and in Peco Foods (T.C. Memo. 2012-18) the Tax Court held a buyer bound by its written allocation schedules and did not allow a change of accounting method based on a later study. Outside §1060, the IRS Cost Segregation Audit Techniques Guide says it is unclear whether the same result applies.
How does purchase price allocation affect depreciation recapture when the property is sold?
Purchase price allocation affects depreciation recapture when the property is sold because it decides how much basis is depreciable at all, and recapture is computed on the part of that basis a cost segregation study places in each recovery class; on a taxable sale at a gain, outside the Opportunity Zone 10-year rule (a qualifying investment held 10 years with the IRC §1400Z-2(c) election), §1245 recapture on the 5- and 7-year property is ordinary income, as is §1250 recapture of the depreciation taken above straight-line (bonus included) on 15-year land improvements held more than one year, and the rest of the depreciation on those land improvements and on the 27.5- or 39-year structure is unrecaptured §1250 gain, taxed at up to 25% for a noncorporate taxpayer. Land was never depreciated, so the part of the gain allocated to it carries no depreciation to recapture.
