Purchase Price Allocation
When you buy a property, the price must be split between land and building, and a study then divides the building portion further. How that split is made affects every later number. A written allocation in an applicable asset acquisition can bind the parties.
Educational information, not tax advice.
Updated 2026-10-14
Key takeaways
- Land is valued first; the building and improvements share the rest.
- A written allocation agreed in an asset acquisition can bind the parties under §1060.
- The IRS audit guide rejects forcing estimates to match the price with a pro-rata step-up.
- Section 1060 applies only when the assets constitute a trade or business.
- Peco Foods held a buyer to its purchase-agreement allocation and refused a later re-allocation.
A purchase price covers land, which is not depreciable, and improvements, which are. The allocation between them is often the single largest judgment in an acquisition. Publication 527 describes using the relative fair market values, and notes that assessed values for real estate tax can be used if there is no better basis.
For an acquired property, the IRS audit guide expects a study to value land first, at its highest and best use, and then estimate the replacement cost new less depreciation of the improvements. That estimate should approximate the purchase price less the land value.
Section 1012 sets basis at cost. The allocation does not change the total. It decides how much of that cost can be depreciated and how much sits in land. A study that moves value out of land without support is changing basis, not classifying components.
Section 1060 adds a special rule when the purchase is an applicable asset acquisition — a transfer of assets that constitute a trade or business, with cost basis to the buyer. In that setting, consideration is allocated using the residual method, and a written buyer–seller allocation generally binds both parties unless the IRS determines it is not appropriate.
Many rental-building purchases may not meet the trade-or-business test for §1060. The official method for those purchases, beyond relative values and the Publication 527 assessed-value note, was not established in the October 2026 research session. Educational information, not tax advice.
Agreed allocations
Section 1060 applies to acquisitions of assets that make up a trade or business. If the buyer and seller agree in writing to an allocation, it generally binds both. In Peco Foods v. Commissioner, the Tax Court and the Eleventh Circuit held a buyer to the allocation in its purchase agreement and refused a later cost segregation re-allocation of the same assets.
Peco is a risk on acquisition pages. It is not a rule that every real-estate closing has a binding §1060 schedule. The statute’s scope is the applicable asset acquisition. The audit guide notes that how far similar agreement principles reach beyond that setting is a question to watch.
If a purchase agreement will include an allocation among land, building, and personal property, read it before closing. Changing it after the study is written may be too late.
Reconciling to the price
Estimates rarely total exactly to the price. The audit guide states that applying a uniform step-up factor to all estimates to force reconciliation is not an acceptable method. Differences should be explained, for example by obsolescence or by intangibles included in the price.
Replacement cost new less depreciation (RCNLD) is the estimating frame the guide describes for used property. Physical deterioration and functional obsolescence reduce the new-cost estimate. The result should come near the price less land.
If the price is far above replacement cost, the excess may be land, going-concern value, or another intangible. Forcing that excess onto 5-year property is the step-up problem the guide rejects.
Before you sign
If a purchase agreement will include an allocation schedule, it is worth discussing with your CPA before closing, since that schedule may limit what a later study can do.
Appraisals, assessor ratios, and seller-prepared schedules are evidence. None of them is automatically the tax allocation. Your CPA decides what the return will use.
Related-party purchases add bonus and §179 limits. Property bought from a related person may fail the purchase tests even if the price is allocated carefully.
What the study does after land is set
Once land is removed, the study divides the depreciable remainder among personal property, land improvements, and the building. That second split uses engineering take-offs and the classification tests, not a second negotiation of the purchase price.
Separately invoiced personal property that the buyer already owns should be left on its own basis. It is not part of the building price to be reallocated.
Limits of this article
The research register marks the allocation method for non-business real-estate purchases as an open question beyond cost, relative fair market values, and the Publication 527 assessed-value note. This page does not invent a required appraisal method.
Peco’s reach outside §1060 acquisitions is also a reviewer item. Treat the case as a warning about written allocations, not as a holding that every residential closing is locked. If the agreement is silent, the study still has to value land and reconcile improvements to the price. Silence is not permission to skip that split.
Sources
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- 2IRS Publication 5653 — Cost Segregation Audit Techniques Guide (rev. 2-2025)(opens in a new tab)
Written for IRS examiners. The guide states it is not an official pronouncement of law and cannot be cited as authority. It predates the July 2025 law.
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