Purchasing raw (unimproved) land can be a great way to get into real estate investing. Raw land is ordinarily cheaper than land with buildings and other improvements.
Moreover, you don’t have the expense of handling building maintenance and other upkeep, not to mention the headaches of dealing with tenants if you rent improved property.
But the tax benefits for owning raw land as an investor are much more limited than for improved property. Some expenses are deductible as itemized personal deductions. Many others aren’t deductible at all. Moreover, if you don’t itemize, you get no immediate benefit from your deductions.
Property Taxes
An investor can deduct property taxes paid on vacant land as a personal itemized deduction on Schedule A. Such taxes should be reported as “Other Taxes” on line 6 of Schedule A.1
This deduction is not limited to the amount of net investment income. Nor is it subject to the $10,000 annual limit on deducting property tax paid on a main or second home. The $10,000 limit, enacted for 2018 through 2025 by the
Tax Cuts and Jobs Act (TCJA) does not apply to investment property.2
Example. In 2024, Art Acres pays $15,000 in property tax on his personal residence and $5,000 in property tax on vacant land. His residence property tax deduction is limited to $10,000. But he may deduct the entire $5,000 paid for the vacant land.
Interest
Interest paid on money borrowed to purchase raw land is deductible as investment interest and can be deducted as an itemized personal deduction on Schedule A. But the annual deduction for investment interest is limited to the investor’s net investment income for the year. Any excess is carried over to any number of future years.3
You determine the amount of your net investment income by subtracting your annual allowable investment expenses (other than interest expenses) from your investment income. Investment income includes taxable interest, ordinary dividends, royalties, and short-term capital gains.
Qualified dividends and long-term capital gains are not considered investment income for these purposes due to their favorable tax rate.
You can make an election to tax these items at ordinary income tax rates in order to include them as investment income, thereby increasing the limit on deductible investment interest expense. If you make this election, however, you must treat the elected capital gains as ordinary income. This prevents taxpayers from receiving both the favorable capital gains tax rates and a deduction for investment interest based on the same net investment income.
This is all calculated on Form 4952, Investment Interest and Expense Deduction.4 The allowable deduction amount is then transferred to line 9 of Schedule A.
Example. George purchases a vacant lot on which he pays annual property taxes of $1,000 and interest of $2,000. His only investment income is $2,000 in annual interest. His net investment income is $1,000 ($2,000 interest income - $1,000 property tax expense = $1,000). Thus, he may deduct only $1,000 of his interest expense. The excess $1,000 is carried over to future years.
Other Expenses Not Deductible
Until 2018, other carrying costs for raw land, such as legal and accounting fees, insurance, and travel expenses, could be deducted as miscellaneous itemized deductions on Schedule A, to the extent they exceeded 2 percent of the taxpayer’s adjusted gross income.
But the TCJA eliminated all such deductions by individual taxpayers during 2018 through 2025.5 And you can’t add these expenses to your property’s basis as described below.
Thus, these expenses have no tax benefit from 2018 through 2025. (We think this is unfair. And we would change it if we were in charge.) The deduction for miscellaneous itemized expenses is scheduled to return in 2026, but the denial of itemized deductions could be extended by Congress.
Land Preparation Costs
Land itself is not depreciable because it has no determinable useful life.6 Thus, you get no depreciation deduction for the cost of vacant land. But what about the cost of preparing land for use, such as grading, clearing, excavation, and landscaping?
Land preparation costs are depreciable only if they are “directly associated” with a building or other structure such that their useful life will end when the structure’s useful life ends. For example, the cost of shrubbery immediately adjacent to apartment buildings is depreciable because the shrubbery would be retired at the same time as the buildings.7
On the other hand, land preparation costs “inextricably associated” with land itself have no useful life and may not be depreciated. The cost must be added to the property’s basis. This includes the cost of initial land clearing; general grading and shaping of land; and other improvements not done to provide a proper setting for a specific building, roadway, or other structure.8
If You Don’t Itemize
If you don’t itemize your personal deductions on your tax return, you won’t be able to deduct the property tax and interest expenses you incur from owning vacant land. In this event, you should elect to capitalize them—that is, add these expenses to your land’s cost basis.
This will reduce any taxable profit you earn when you sell the property for a capital gain. Adding the expenses to the land’s basis isn’t as good as a current deduction at ordinary income tax rates that are as high as 37 percent, but it’s better than no deduction at all.
Example. Jean purchases a vacant lot for $10,000. Over the next four years, she elects to capitalize $2,000 in carrying costs each year. At the end of the four years, her adjusted basis in the lot is $18,000. She sells the lot for $20,000. Her taxable gain is only $2,000 ($20,000 sales price - $18,000 adjusted basis = $2,000). She has saved $1,200 in capital gains tax (15 percent x $8,000).
You must make an annual election to capitalize these costs. You can elect to capitalize all your costs, or to capitalize some and not others—for example, you could capitalize interest but not property taxes. If you wish, you can make the election in some years you own the property and not make it in others.9
To make this election, you should add a statement such as the following to your tax return:
For tax year _____, taxpayer hereby elects under IRC Code Section 266 and IRS Regulation 1.266-1 to capitalize, rather than deduct, the following carrying costs for the property located at [address]:
Description | Amount |
Describe cost. | $ |
Describe cost. | $ |
Describe cost. | $ |
What About the Passive Loss Rules?
The passive loss rules prevent taxpayers from deducting passive activity losses from salary and portfolio income.
Passive activities include rental activities and trades or businesses in which taxpayers don’t materially participate.10 Holding raw land for investment is ordinarily not a rental activity, which is defined as the receipt of payments “principally for the use of tangible property.”11 Even if raw land is leased, it still won’t be a rental activity if the lease is merely “incidental” to holding the land for investment.12
Also, holding raw land for investment purposes (that is, for purposes of appreciation) is ordinarily not a trade or business.13 The only exception is where a developer holds land in anticipation of developing it. In this event, the “activity” of holding the land could constitute a business. This would make the costs of holding the land subject to the passive loss rules.14
Thus, investment in raw land to obtain appreciation is ordinarily not a passive activity subject to the passive loss rules.
Takeaways
Here are four takeaways from this article:
- Property tax and interest paid for an investment in raw land are deductible as personal itemized deductions on Schedule A. The property tax deduction for raw land is not limited to $10,000, as is the personal deduction for other property taxes. But the deduction for investment interest is limited to annual investment income.
- Other carrying costs for raw land, such as legal and accounting fees, insurance, and travel expenses, are miscellaneous itemized deductions that are not deductible during 2018-2025.
- Taxpayers who don’t itemize get no current tax benefit for their property tax or interest costs of owning raw land. But they may elect to add those costs to the property’s basis by filing an annual election with their tax return. This will reduce their taxable profit when they ultimately sell the property.
- Land preparation costs such as grading, clearing, and excavation are not depreciable if they are “inextricably associated” with land itself—that is, if they are not done to provide a proper setting for a specific building, roadway, or other structure. The non-depreciable land preparation costs must be added to the land’s basis.
__________________________
IRS Form 1040, Schedule A, Itemized Deductions (2023).
IRC Section 164(b)(6).
IRC Section 163(d).
IRS Form 4952, Investment Interest Expense Deduction (2023).
IRC Section 67(g).
Reg. Section 1.167(a)-2.
Rul. 74-265.
Rul. 2001-60.
Reg. Section 1.266-1(b)(1)(i).
IRC Section 469(c)(1),469(c)(2).
IRC Section 469(j)(8).
Reg. Section 1.469-1T(e)(3)(vi)(B).
Reg. Section 1.469-4(b)(1).
Reg. Section 1.469-4(b)(1)(ii).