Investing in land is similar to investing in a rental property. Any costs incurred to initially acquire land, including closing and up-front financing costs, are capitalized as basis in the investment and are not deductible at the time of purchase.
However, this doesn’t mean there aren’t deductions available for land investments. Since raw land typically does not produce income, it is a loss-making investment when looking purely at income matched against expenses. Of course, if the land appreciates, it can become a profitable investment.
In this article, we’ll discuss ways to deduct expenses from a land investment.
Vacant or Improved Land
There are two types of land — vacant and improved. Vacant land is straightforward — it will continue to generate a loss while incurring expenses.
Land expenses include:
- Maintenance (mowing the grass, trimming trees, firewise, etc.)
- Property taxes
- Any financing cost
Note that land generally cannot be leveraged, and thus financing can be difficult to come by.
The above are expenses rather than capital costs. The reason why is because these expenses aren’t improving the land.
Improved land is property that the owner has added some utility to the property. This might be a building, roadway, sidewalk, or parking lot. All add value to the property. Because these are improvements, they can be capitalized. This falls under Code Section 266 (§266 Election).
With added value comes additional taxation. The property will be assessed at a higher value, which generates a larger property tax bill. Note that many states have property assessment limits on annual increases. These percent increase limits are usually in the low single digits.
If the property owner's intention is not to improve the property, they should be careful about even minor changes such as moving dirt around or subdividing out the property. This can make the property appear as inventory for development rather than an investment, bringing into question, is the owner a dealer or investor? If a dealer, property is taxed at ordinary income rates instead of long-term capital gains rates.
Tax Treatment of Property Taxes
As mentioned earlier, land is a negative income business. Any income does not offset expenses. That doesn't mean those expenses can't be declared on the investor's tax return. Expenses from land are itemized and go on Schedule E. These expenses can offset income on other investment properties.
While a land investment is not directly tax deductible, expenses incurred from the investment are tax deductible. Investors should understand the impact any land improvements will have on their property taxes, whether the improvements are intentional or not. Working with an experienced real estate accountant can help investors navigate if land is being improved and what any tax impact might be.