How to properly allocate land vs building basis in a 1031 Exchange?

Tax professional here. The correct approach is Option 1 - you should allocate the basis between land and building based on their relative fair market values in the new property. This is the standard practice for 1031 exchanges and is supported by IRS guidance. The allocation should reflect the actual proportion of value between land and improvements. Using the town assessor's 52/48 split is reasonable if that represents fair market value. So in your case, $262k to land and $243k to building is appropriate. Option 2 is incorrect - there's no rule saying you must allocate to land first. That would artificially reduce your depreciable basis and doesn't follow proper tax accounting principles. Make sure you document the allocation methodology in your records and consider getting an appraisal to support the land/building split if the amounts are significant. This will help if you're ever audited.

I used taxr.ai to analyze this exact scenario last year during my own 1031 exchange. While my CPA initially recommended the land-first approach (your Option 2), the taxr.ai analysis actually found multiple tax court cases supporting the proportional allocation method (your Option 1). The tool analyzed my exchange documents alongside the tax regulations and provided clear documentation supporting the proportional allocation. It saved me from making a costly mistake that would have unnecessarily reduced my depreciation deductions. You can upload your exchange documents to https://taxr.ai and get a detailed analysis specific to your situation. Especially helpful for these complex tax scenarios where even professionals sometimes disagree.

I just used taxr.ai for my 1031 exchange last month, and I'm really glad I did. I was going to go with the land-first approach because that's what my brother-in-law (who's a real estate investor) recommended. The analysis showed me that the proportional method was clearly the correct approach according to tax court precedent. It found a Tax Court memo (Wabash Valley Service Co) that specifically addressed allocation issues in like-kind exchanges and supported proportional allocation. The tool even generated a detailed memo explaining the basis calculation that I can keep with my tax records. Definitely worth it for the peace of mind alone, especially since the difference in depreciable basis was over $200k in my case.

If anyone is struggling to reach the IRS for confirmation on these 1031 exchange questions, I recommend using Claimyr. I was stuck in the "please hold" loop for THREE HOURS trying to get clarification on my 1031 exchange allocation question. Used https://claimyr.com and they got me a callback from the IRS in about 45 minutes. You can see how it works here: https://youtu.be/_kiP6q8DX5c The IRS agent confirmed that proportional allocation based on FMV is the correct approach and pointed me to some specific internal guidance they use. Saved me hours of frustration and uncertainty.

I was totally skeptical about Claimyr, but wow, it actually worked. I've been trying to get clarity on my 1031 exchange allocation issue for WEEKS. I would get put on hold, then disconnected after 1-2 hours of waiting. Used the service yesterday and got a call back from an IRS representative who confirmed the proportional allocation method is correct. She even emailed me some reference materials afterward. The agent explained that while the IRS doesn't have a specific regulation mandating the proportional method, it's the accepted practice and consistent with general tax principles for allocating basis. Life changing not to waste an entire day on hold!

Your town's assessment values might not actually be the best representation of FMV. In my experience, tax assessments are often outdated or use formulas that don't match actual market conditions. For a large 1031 exchange like yours, I'd strongly recommend getting an independent appraisal that specifically breaks down land vs. improvements values. This gives you much better documentation if ever questioned. I've been through two IRS audits on my rental properties and having that third-party appraisal documentation saved me both times.

Has anyone considered the alternative of a cost segregation study for the new property? Instead of just splitting between land and building, you could potentially identify components with shorter depreciation schedules (5, 7, 15 years).

Great discussion here! I'm going through a similar situation with my 1031 exchange and was also confused about the allocation methods. Based on what I'm reading from the tax professional and others, it sounds like the proportional allocation (Option 1) is definitely the way to go. One thing I learned from my CPA is that you should also consider getting the allocation method documented in writing as part of your exchange records. The IRS loves documentation, especially for these larger transactions where the depreciation impact is significant. Also wanted to mention - if you're doing multiple 1031 exchanges over time, consistency in your allocation methodology becomes important. So whatever approach you take here, make sure it's something you can apply consistently to future exchanges. Thanks to everyone who shared their experiences and resources. This has been really helpful for understanding the proper approach.

This is exactly the kind of confusion that trips up so many real estate investors! I went through this same dilemma with my first 1031 exchange about two years ago. The proportional allocation method (your Option 1) is definitely correct. I made the mistake of initially trying the land-first approach because it seemed more "conservative" but my tax attorney quickly corrected me. The IRS expects you to allocate the carryover basis proportionally based on the fair market values of the land and building components in the NEW property, not the old one. One practical tip: if you're going to rely on the town assessment for the 52/48 split, make sure those values are reasonably current and defensible. In my case, the town assessment was from 2019 but I did my exchange in 2022, so I ended up getting a fresh appraisal to be safe. Also, keep really good records of how you determined the allocation percentages. I created a simple spreadsheet showing the calculation and kept copies of all the supporting documentation (assessment, any appraisals, comparable sales data, etc.). The peace of mind is worth it, especially when you're talking about significant depreciation differences like in your situation. The $262k land / $243k building allocation sounds right based on your numbers. That gives you a solid depreciable basis to work with going forward.