Why Leveling a Mountain Isn't Depreciable
In the strategic world of real estate taxation, cost segregation is a powerful tool for accelerating depreciation. However, its power is defined by a critical and non-negotiable boundary: the permanent, non-depreciable nature of land. A recent federal court ruling has delivered a stark reminder that misclassifying land preparation costs can negate these benefits and lead to significant compliance issues. But what is the essential distinction between depreciable site improvements and non-depreciable land preparation? Every property owner, developer, and tax professional must understand this, so we prepared this article for you.
Land Does Not Depreciate
The foundation of this issue is established in the Internal Revenue Code (§263). Land is considered an asset with an indefinite useful life. It does not wear out, become obsolete, or get used up. Therefore, any expenditure that permanently improves the land or prepares it for its intended use must be capitalized into the land's basis. This capitalized cost is not depreciable.
A Landmark Reaffirmation: Eastwood Mall Inc. v. U.S.
The recent case of Eastwood Mall Inc. v. U.S. powerfully reinforces this principle. The taxpayer argued that the monumental cost of leveling a mountain to create a buildable site should be depreciable. The court firmly disagreed, ruling that this activity fundamentally improved the land itself, not any future depreciable structure. The intent to build was irrelevant; the nature of the expenditure was to create a usable parcel of land. As a result, the costs were added to the land's basis, providing no depreciation deductions. This aligns with a long history of precedent, such as Mount Morris Drive-in Theatre Co. v. Commissioner, where grading costs were deemed part of the land's permanent cost.
What Constitutes a Non-Depreciable Land Cost?
It is crucial to distinguish between preparing the land and improving a prepared site. The following common costs must be capitalized into the land's basis and are not depreciable:
Clearing and Grubbing: Removal of trees, stumps, and natural vegetation.
Mass Excavation and Grading: Significant earth-moving to create a level building pad, even on a dramatic scale.
Filling: Adding soil to stabilize or elevate the land's surface.
Demolition of Existing Structures: Costs to raze existing buildings to make the land vacant and ready for new development.
Environmental Remediation: Cleaning contaminated soil or groundwater to make the land suitable for use.
The courts' consistent reasoning is that these activities benefit the land in its entirety, making it suitable for any use, and are not uniquely tied to the specific depreciable asset built later.
A high-quality cost segregation study is not just about accelerating depreciation; it is equally about correctly identifying and excluding non-depreciable costs.
In the context of land, we should be making a clear distinction:
✅ Depreciable Site Improvements: These are assets built upon the prepared land with a determinable useful life.
Examples: Paved parking lots, sidewalks, fencing, landscaping irrigation systems, and site lighting.
Recovery Period: Typically 15-year property.
❌ Non-Depreciable Land Preparation: These are activities that make the raw land suitable for construction.
Examples: The grading and filling done before the parking lot sub-base is installed.
Treatment: Capitalized to land basis.
The updated IRS Cost Segregation Audit Technique Guide (ATG) for 2025 places a strong emphasis on the quality and defensibility of these studies. It underscores that a compliant study must be prepared by qualified professionals with expertise in construction, engineering, and tax law; provide detailed documentation that justifies the allocation of costs, including a clear methodology for separating land preparation from land improvements; and explicitly exclude non-depreciable land costs from the calculation of accelerated depreciation. A study that fails to properly segregate land preparation costs invites an IRS adjustment, penalties, and interest.
Compliance is the Key to Savings
The promise of accelerated depreciation through cost segregation is compelling, but it must be pursued within the boundaries of established tax law. The principle that land preparation costs are non-depreciable is not a loophole; it is a foundational rule, recently reaffirmed by the courts. For developers and investors, the message is clear: transforming raw land by clearing trees or moving mountains is a capital investment in a permanent asset. A meticulous and defensible cost segregation study respects this boundary, ensuring that your tax strategy is both aggressive in its savings and impeccable in its compliance. Before proceeding, ensure your tax advisors and engineering professionals are meticulously classifying these costs to secure your deductions without the risk of a costly reversal.