Investment San Diego, California real estate is composed of two items, the land and the structure; only the structure can be depreciated. Because land is not depreciable, its value must be subtracted from the total original basis to arrive at the depreciable basis, the improvements. Three methods for determining the percentage of improvements are the assessed value method, the appraisal method and the contract method.

Assessed Value Method

The county assessor's property tax statement now lists the full cash value of the land and the improvements. The value of the improvements for depreciation purposes is thus the assessor's determination of the part of the purchase price that represents the value of the improvements.

EXAMPLE: Ms Adams purchased San Diego real estate for $100,000 and received the following tax bill from the county assessor's office:

Assessed Value:

The improvements give Ms Adams a depreciable basis of 70 percent of her purchase price plus buying expenses.

Appraisal Method

A real estate owner may secure the services of a professional appraiser to appraise the building and land. The appraisal method may give either a more or a less favorable ratio than the assessed value method. The taxpayer should compare the ratios from the two methods to verify which is more advantageous.

Contract Method

One other method of determining the percentage of improvements is the contract method. With this method the buyer and the seller determine the relative values of the improvements and land and designate these values in the contract, deposit receipt or escrow instructions. Note that the determination must be at arm's length and reasonable. Before using this method, we strongly suggest obtaining professional help.

Adjusted Basis

The adjusted basis is the amount that the client has invested in the property for tax purposes. In other words, the adjusted basis is equal to original basis, plus improvements made, less all depreciation taken.

Adjusted basis = Original basis + Improvements - Depreciation

It is extremely important that the homeowner or investor understand the relationship between the basis and the final sales price of the property, because basis is the beginning point for calculating the amount of gain or loss on the sale. Calculation of the basis is affected by how the property originally was acquired.

Basis by purchase is the price paid for the property, as described above.

Basis by gift is the donor's (gift giver's) adjusted basis plus the gift tax paid, not to exceed the fair market value at the time of the gift.

Basis by inheritance generally is the fair market value at the time of the owner's death.

Computing Gain

The basis is the beginning point for computing the gain or loss on the sale, but numerous adjustments to the basis always are made during the ownership period. Some of the costs that increase the basis are title insurance, appraisal fees, legal fees, cost of capital improvements and sales costs on disposition. Accrued (past) depreciation is deducted from the basis. The result is the adjusted basis.

Capital gains due to depreciation are now taxed at the regular capital gains tax rate (20 percent). (They were formerly taxed at a 25 percent rate.)

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