A property’s assessed value is calculated for tax purposes and is comprised of improvement value and land value. When speaking of improvement value in commercial real estate, improvements include all accessible buildings and structures on that land, not necessarily that there have been recent improvements made to that property.
Understanding Improvement Value in Commercial Real Estate
Your commercial real estate property is divided into the land/lot, and your improvements. Improvement value in commercial real estate is the value that sits on top of the land.
An assessor places a certain value on a property to determine a tax assessment for the improvement portion of the property. This includes structures, streets, and even sewer connections that are on that piece of land. Because land does not depreciate, the improvement value will be the depreciable amount. Improvement value varies by county, and the assessment value typically has no relation to its market value.
Land Value vs. Improvement Value
Since land cannot depreciate, you must allocate the original purchase price between the land and the structures or improvements on top of it. Using the values from the property tax assessor, you can calculate the ratio of the value of the land to the value of the improvements.
To calculate the ratio, you must take the original purchase price of the property and split it into two subcategories: land value and improvement value. The improvement value is the difference between the total purchase price of the commercial real estate property and the land value, plus the cost of buildings and other improvements added.
Calculating Improvement Value in Commercial Real Estate
The higher the improvement ratio, the higher the amount of value allocated to the property and a lower amount allocated to the land. This results in a higher annual depreciation amount.
Here’s an example: You purchase a piece of commercial real estate for $1 million with a 90% improvement ratio. That means $900,000 of value is allocated to the building and improvements, which is depreciable over the asset’s useful life, and $100,000 is allocated to the land. Keep in mind that the improvement ratio will never be 100% as land always has value.
There are three ways to determine your improvement ratio:
- Property tax card: A representation of what the assessor thinks your property is worth.
- Buyer/seller appraisals: Having an appraisal on your property can help you calculate your improvement ratio.
- Replacement cost and land sale comps: Appraisal reports and insurance estimates typically provide a value for replacement cost. Replacement cost is the cost to construct a new asset according to its current worth. Land sale comps can also be accessed to determine the value of the land and can be found from a variety of sources, including third-party websites, county offices, or agents with access to the MLS.
Knowing your improvement value on your commercial real estate property will be useful when tax season comes around. Calculating your improvement ratio to increase your annual depreciation expense will be one of the most helpful calculations you will make.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation. All real estate investments have the potential to lose value during the life of the investment. All financed real estate investments have the potential for foreclosure.