We can use the appraisal amounts for dividing the actual cost of $220,000 into the cost of the land and the cost of the building. There are two related techniques which will have the same results.
- Since the appraisal report indicated that the land's value is $50,000 out of the $250,000 of total appraised value, we can assign 20% (50/250) of the total cost of $220,000 to the land, or $44,000. The building's appraised value is $200,000 out of the $250,000 total appraised value. Therefore we can assign 80% (200/250) of the total cost of $220,000 to the building, or $176,000.
- The real estate's total cost of $220,000 is 88% of the total appraised value of $250,000. We can multiply the land's appraised value of $50,000 times 88% in order to get the cost of the land at $44,000. The building's appraised value of $200,000 times the 88% cost ratio equals the cost of land at $176,000.
A self-check of both calculations indicates the same costs: land at $44,000 plus the building at $176,000 equals the total actual cost of $220,000.
We did not deviate from the cost principle. We merely used the appraised market values as a logical way to divide up the actual cost between the land and building. This assignment or allocation is necessary because the cost of the building used in a business will be depreciated, while the cost of the land is not depreciated.