Real Estate Sale Allocations: the Split Between Land, Building, and Personal Property

Two investors sell identical $600K properties. One pays $46K in tax. The other pays $72K. The difference isn’t the sale price, the hold period, or some exotic structure. It’s how the sale price got allocated across the assets.

Most investors treat a sale like one number: I sold for $600K, here’s my gain. But the tax code doesn’t see one asset. It sees a bundle of land, building, and personal property, and each piece is taxed at a different rate.

How you split the price across those buckets is what actually sets your bill. And most of the time, nobody plans it.

One Sale, Three Buckets, Three Rates

When you sell a depreciated rental, §1001 gives you the gain (amount realized minus adjusted basis), but the character of that gain depends on which asset it came from. Your total price has to be allocated across three categories, and they don’t get taxed the same way.

Land. No depreciation, so no recapture. Pure §1231 gain that lands at long-term capital gain rates under §1(h) — a top rate of 20%. This is the cheapest bucket.

The building: §1250 property. Here’s the one people get backwards. If you used straight-line depreciation (which you did, real property has no other option since 1986), there’s no “§1250 recapture” in the ordinary-income sense. Instead, the depreciation you took comes back as unrecaptured §1250 gain, taxed at a maximum 25% under §1(h)(1)(E). Higher than land, but still a preferential rate.

Personal property: §1245 property. This is the expensive bucket. The 5-, 7-, and 15-year components you pulled out in a cost seg study are §1245 property, and §1245 recapture is fully ordinary to the extent of depreciation taken, up to 37%. The accelerated deduction you loved on the front end comes back at ordinary rates on the back end.

So the same dollar of gain can cost you 20%, 25%, or 37%, depending on which bucket it’s assigned to. That’s the whole game.

The Allocation Directly Controls Your Recapture Exposure

Line the rates up, and the strategy writes itself:

• More to land = no recapture = lowest tax (20%)
• More to building = unrecaptured §1250 gain in the middle (25%)
• More to §1245 personal property = full ordinary recapture = highest tax (up to 37%)

The investor who paid $46K instead of $72K didn’t do anything clever. They just had a defensible allocation that put more of the price on land and building and less on the §1245 components, and they could prove it.

This is also the quiet cost of an aggressive cost seg you never plan to unwind. The bigger the §1245 bucket you created at acquisition, the more ordinary recapture is sitting there waiting at sale.

That’s not a reason to skip the cost seg. The time value of the front-loaded deduction usually still wins. But it is a reason to model the exit before you sell, not after.

Buyer and Seller Want Opposite Things

The allocation isn’t yours to set alone. There’s someone on the other side of the table with the exact opposite incentive.

You, the seller, want more weight on land (no recapture) and building (25%), and as little as possible on §1245 (ordinary).

The buyer wants the opposite, more to personal property, because they get to depreciate it fast and grab bonus on it. Your expensive bucket is their favorite bucket.

That tension is exactly what the IRS likes to see.

Under §1060, certain sales (an “applicable asset acquisition” — a going concern, or any deal where goodwill could attach) require both sides to allocate using the residual method across asset classes, and to report it consistently.

Pub 544 says it plainly: when adverse parties negotiate the allocation at arm’s length, the IRS will generally respect it. If there’s no agreement, the IRS allocates to fair market value itself — and they’ll happily use your own cost seg study as the evidence for a bigger §1245 number.

The lesson: get the allocation written into the purchase and sale agreement at closing, while the other side’s opposing interest still makes it credible.

The County Assessor Trap

Here’s where most investors quietly hand money away.

At acquisition, you needed a land/building split to start depreciating, so you used the county assessor’s ratio, because it was sitting right there on the tax bill. Then you never thought about it again.

The problem: assessor allocations are built for property tax, not income tax, and they frequently over-allocate to land. Over-allocate to land at acquisition, and you depreciate less every year you hold.

The fix is an acquisition appraisal — an independent, defensible split that usually puts more value on the depreciable building than the assessor did, and gives you a number that survives an exam.

When to Get an Appraisal

Two moments matter:

• At acquisition: establishes your depreciable basis allocation from day one, ideally more building, less land than the assessor’s lazy split.
• At sale: if land has appreciated a lot relative to the building, a current appraisal can support a higher land allocation on the sale side, which means less recapture. Your incentives literally flip between buy and sell: at the buy you want building, at the sell you want land. An appraisal at each end lets you defend both.

And any time the assessor split just doesn’t look right, that’s your signal to get a real one.

Don’t Let  Your Acquisition Story Contradict Your Exit Story

If you ran a cost seg on the buy side, your sale allocation needs to be consistent with it. You can’t tell the IRS the §1245 components were worth a fortune when you wanted the deduction, then claim they’re worth nothing when you want to dodge recapture. Pick a story and let your documents tell it the same way at both ends.

And if you’re the buyer on one deal and the seller on another in the same year, run them together. Your incentives point in opposite directions, and you can plan around that.

Form 8594: When You Need it and When You Don’t

Quick myth-bust, because this trips people up. Form 8594 (the asset acquisition statement under §1060) is not generally required for a standard real estate sale. A plain rental property has no goodwill or going-concern value, so there’s nothing for the §1060 residual method to do.

You do need it when you’re selling a business that carries goodwill or going concern value — mobile home parks, RV parks, branded or operating hospitality, anything with an operating enterprise attached. That’s an applicable asset acquisition, and both sides file 8594 with matching numbers.

But here’s the part that matters even when 8594 isn’t required: the allocation still drives your Form 4797. The 4797 is where land, §1250, and §1245 gain get separated and rated. So even on a vanilla rental with no 8594, the split between buckets is doing all the work on your return.

What To Do With This

• If you’re selling this year: have your CPA model the allocation impact before you agree to terms. The PSA is where the number gets locked, and after closing it’s far harder to move.
• If you’re buying: push for more allocation to §1245 personal property in the PSA — that’s your fast depreciation and bonus.
• If you acquired without an appraisal: it’s not too late to get one for basis support, but the further you are from the acquisition date, the harder a retroactive number is to defend. Sooner is cheaper.

The way your sale price is allocated can have a significant impact on your tax bill. Our team helps real estate investors model different allocation scenarios, evaluate depreciation recapture, and develop tax-efficient exit strategies before closing. Schedule a consultation today.