Land Improvements

Land improvements are additions or enhancements to a piece of land that make it more useful but that wear out or need replacing over time. Common examples include paved parking lots, driveways and sidewalks, fences and gates, outdoor lighting, drainage and irrigation systems, retaining walls, landscaping such as shrubs and trees, and outdoor signs. Because they have limited useful lives, land improvements are recorded in a separate fixed asset account from land itself and are depreciated over their estimated lives.

The distinction matters because land is not depreciated. Land is assumed to have an indefinite life, so its cost stays on the balance sheet unchanged until it is sold, unless it is impaired. If land improvements were added to the land account, their cost would never be expensed, overstating assets and profit. Separating them ensures that their cost is spread over the years in which they benefit the business, through depreciation.

Accountants generally classify real estate costs into three groups:

• Land includes the purchase price, closing costs, title fees, surveying, real estate commissions, the cost of clearing, grading and filling the land, and demolishing an old building to prepare the site. These costs are not depreciated.
• Land improvements include the additions described above that sit on the land and have limited lives. They are depreciated, typically over 10 to 20 years.
• Buildings include the construction or purchase cost of structures, along with permanent fixtures that form part of them, and are depreciated over longer lives.

Some items are judgment calls. Special assessments by a local government for permanent public infrastructure, such as streets and sewers that the government will maintain, are usually added to the cost of land, because the business does not have to replace them. Improvements the business itself must maintain and replace, such as its own private road or parking lot, are land improvements. Improvements to leased property are recorded separately as leasehold improvements.

A distribution company buys a vacant lot for $800,000 and pays $25,000 in legal and title fees and $40,000 for grading. It then spends $180,000 paving a parking lot and loading area, $30,000 on perimeter fencing and $20,000 on outdoor lighting.

• The land account is $800,000 plus $25,000 plus $40,000, which totals $865,000, and is not depreciated.
• The land improvements account is $180,000 plus $30,000 plus $20,000, which totals $230,000.
• If the improvements have an estimated useful life of 15 years with no salvage value, straight-line depreciation is $230,000 divided by 15, or about $15,333 a year.

Each year the company debits depreciation expense and credits accumulated depreciation on land improvements for about $15,333. After five years, the improvements have a book value of about $153,333, while the land remains at $865,000. Many companies depreciate different types of improvement over different lives, for example paving over 15 years and landscaping over 10.

For US federal tax purposes, most land improvements are classified as 15-year property under the Modified Accelerated Cost Recovery System, which allows faster write-offs than straight-line depreciation over the same period, and they may qualify for bonus depreciation. This is shorter than the 39-year recovery period for nonresidential buildings, so correct classification can produce significant tax savings; businesses sometimes commission cost segregation studies to identify components that qualify. The difference between book and tax depreciation creates deferred tax liabilities on the company's books.

In the financial statements, land improvements are usually included within property, plant and equipment, with the breakdown by asset class given in the notes. Later spending on improvements follows normal capitalization rules: resurfacing a parking lot that extends its life is capitalized, while routine repairs such as filling potholes are expensed. When improvements are removed or replaced, their remaining cost and accumulated depreciation are written off, as described in the entry on disposal of fixed assets. The economic concept of land as a factor of production is covered separately in the entry on land (economics), and the wider category is explained in the entry on fixed assets.