Land investment is like investing in rental properties. The costs involved in purchasing land, such as the cost of closing and financing up-front, are capitalized as the basis for the investment and are not tax-deductible at the moment of purchase.
But, that does not mean there aren’t tax deductions for land investments. Since land generally produces no income, it’s an investment that will lose money if you look only at the income and expenses. However, if this land is appreciated, it could be a lucrative investment.
We’ll look at ways to deduct the cost of an investment in land.
Land That Is Not Occupied Or Improved
There are two kinds of land, namely either improved or vacant. Vacant land is simple -it will continue to make a loss while incurring costs.
The costs for land comprise:
- Maintenance (mowing the grass, trimming trees, fires, etc.)
- Taxes on property
- Insurance
- Any financing costs
It is important to note that land cannot be leveraged and, as such, financing is difficult to find.
The above expenses are more than capital expenses. The reason for this is that these costs aren’t enhancing the condition of the land.
Improved land is a property where owners have added utilitarian value to the land. It could be a building, roadway, sidewalk, or parking area. They all add worth to the land. As they are improvements, they may be capitalized. This is covered in Code Section 266 (SS266 Election).
The added value will result in the possibility of additional taxation. The property is appraised at a greater price, resulting in a greater tax bill. Be aware that several states have limits on property assessments for annual increases. These limits for percent increase typically fall in the lower single numbers.
Suppose the owner’s goal is not to enhance or improve the condition of their home. In that case, they need to be cautious about minor modifications like shifting dirt around or subdividing the property. It could make the property appear to be an inventory for development rather than an investment. This could question whether the owner is a dealer or an investor? The property is taxed at regular income rates instead of the long-term capital gains rate if it is a dealer.
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Tax Treatment For Property Taxes
As I mentioned, the land industry is a business with negative earnings. The income earned does not cover expenses. This doesn’t mean that expenses cannot be reported on the investor’s tax return. The costs associated with land are included and appear in Schedule E. They may be used to offset the income from other investments.
While land investments are not tax-deductible, the expenses that result from the investment can be tax deductible. Investors must be aware of the effect any land improvements can have on their property tax regardless of whether the improvements were deliberate. Engaging a knowledgeable realtor accountant will assist investors in understanding if their improvements are being made to the land and the tax implications.
