Division of land and building
A real estate purchase is a significant financial transaction that can have tax consequences for both buyer and seller. One of the most important aspects of a real estate purchase agreement is the division of the purchase price between the land and the building. This division can have significant tax implications for both parties, as it can affect both real estate transfer tax and income tax. In this blog post, we will take a closer look at the division of land and building in the purchase agreement and highlight the tax implications.
The importance of the division of land and building in the purchase agreement
The division of the purchase price in a real estate purchase agreement between land and building is important for several reasons:
- Real estate transfer tax: the amount of real estate transfer tax that the buyer must pay often depends on the amount of the land portion of the purchase price. In many countries, the real estate transfer tax is calculated on the land portion, while the building portion is tax-advantaged.
- Depreciation: In many tax systems, buildings can be depreciated over a certain period of time, which can lead to tax advantages. An accurate split between land and building is required to correctly calculate depreciation.
- Income Tax: Both buyer and seller may experience tax implications. The buyer may be able to take advantage of depreciation on the building, while the seller may have to pay taxes on any gain from the sale of the land.
Determine the proper division
The exact division of land and building value can vary by region and jurisdiction. However, there are some common methods for determining this apportionment:
- Expert appraisal: An appraiser is often called in to estimate the value of the land and building. This appraiser considers various factors such as location, lot size, year built, condition, and comparative prices of similar properties in the area.
- Percentage Breakdown: A commonly used method is to break down the purchase price by percentage based on comparative data of similar properties. For example, one might determine that 70% of the purchase price is for the building and 30% is for the land.
- Purchase Agreement: The buyer and seller can also agree on a specific split in the purchase agreement. However, this agreement should be fair and reasonable, otherwise tax authorities may object.
Tax implications for the buyer
For the buyer of a property, the tax implications of dividing the land and building in the purchase agreement can be significant:
- Real estate transfer tax: the higher the share of the land in the purchase price, the higher the real estate transfer tax will be. Therefore, a more favorable division may be more advantageous for the buyer.
- Depreciation: The buyer can benefit from the depreciation of the building, as this offers tax advantages. An accurate split between land and building is required to correctly calculate and maximize depreciation.
- Financing: financing may also depend on the division. Most lenders will lend on the building but not the land portion. An accurate apportionment can make it easier to obtain a loan.
Tax implications for the seller
The seller is also affected by the apportionment:
- Capital gains tax: the seller may have to pay capital gains tax on the gain from the sale of the property. A lower land portion of the sale price may reduce the tax burden.
- Income tax: If the seller has used the property for commercial purposes, this may lead to different tax consequences. Professional advice may be useful here.
Conclusion
The division of land and building in the purchase agreement is an important aspect of buying real estate and can have significant tax implications for both buyer and seller. It is advisable to seek professional advice from tax experts and surveyors to determine the best division and maximize tax benefits. Careful planning and advice can help minimize the financial impact of a real estate purchase and make the transaction go smoothly.