How to determine the acquisition value of land for capital gains tax calculation?

Calculating capital gains tax in the event of real estate alienation still raises many practical questions. This is not surprising, as the possible situations vary greatly, and consequently, the results of the tax calculation also differ. Furthermore, the explanations provided by authorities and courts do not always coincide.

In this article, we will look at a situation where real estate consisting of land and several buildings is purchased, but later only part of the land is sold. The value of the land and buildings is not specified separately in the purchase agreement. Therefore, a significant question arises – how to determine the acquisition value of the sold land for capital gains tax calculation in such a situation?

To make the situation easier to understand, let’s look at a practical example.

Factual circumstances

The real estate consists of a 6.4 ha land unit on which several buildings are located.

The real estate (as a single object) was purchased for 60,000 euros, with an additional 1,223.36 euros paid in state and office fees.

Later, only ½ of the land unit (3.05 ha) is sold for 18,800 euros.

How to calculate the capital gain in such a situation if the value of the land and buildings is not separated in the real estate purchase agreement?

Determining the acquisition value by dividing it proportionally to the land area

The first assumption could be that when selling half of the land, its acquisition value is also half of the acquisition value of the entire real estate. Accordingly, the land acquisition value would be:

(60,000 + 1,223.36) / 2 = 30,611.68 euros.

If 3.05 ha of land are sold for 18,800 euros, no capital gain is formed, but a loss occurs. Namely:

18,800 – 30,611.68 = –11,811.68 euros.

Furthermore, such an assumption is not unfounded. Recently, the Senate of the Supreme Court explained how the acquisition value of real estate divided after acquisition should be determined in the capital gains tax calculation.

The Senate pointed out that the legislator has not regulated in detail how the acquisition value of a part of real estate is to be determined in cases where the property is divided after acquisition. In such cases, for the purposes of capital gains calculation, the acquisition value of the entire real estate can be divided proportionally to the area of each separated part. The area of real estate is an easily determinable, effectively administrable, and universal criterion.

In the example considered, this would mean that if the original land area was 6.4 ha, then when selling half of this area, the acquisition value of the sold land would also be half of the total acquisition value.

Approach of the State Revenue Service

In the view of the SRS, such a calculation is not correct.

The SRS believes that to determine the acquisition value of the land, a proportion must be used, the calculation of which takes into account the cadastral value of the land and buildings at the time of the property’s acquisition. The cadastral value in this case is used only to determine the proportion.

Suppose that the total cadastral value of the real estate (land and buildings) at the time of acquisition was 1,570 lats, of which the cadastral value of the land was 492 lats, and the buildings – 1,078 lats.

Accordingly, the share of the land in the total cadastral value was 31.34%, while the share of the buildings was 68.66%.

Taking into account that the real estate was purchased for 61,223.36 euros (including the fees paid), the SRS believes that 31.34% of this amount is attributable to the land acquisition value.

Consequently, the notional acquisition value of 6.4 ha of land is 19,187.40 euros, and the acquisition value of the buildings is 42,035.96 euros.

Next, the acquisition value of one hectare is calculated: 19,187.40 / 6.4 = 2,998.02 euros.

If 3.05 ha are sold, their acquisition value is: 3.05 × 2,998.02 = 9,178.20 euros.

If these 3.05 ha are sold for 18,800 euros, the taxable income is: 18,800 – 9,178.20 = 9,621.80 euros.

As a result, a taxable capital gain arises.

Court approach

If there are no buildings on the real estate, for the purposes of capital gains calculation, the acquisition value of the part of the real estate separated after acquisition can be determined by dividing the original acquisition value of the real estate proportionally to the area of each separated part. The area of real estate is an objective and easily determinable criterion. At the same time, such a method is applicable only if it is not possible to use other objective criteria.

Conversely, if the real estate consists of both land and buildings, the court has recognized that the proportional method is applicable for determining the acquisition value of the land, using the ratio of the value of the land and buildings, similar to how the SRS applies it in its practice.

Conclusions

As can be seen, in the same situation, the capital gains tax calculation can differ significantly depending on the chosen approach and the applicable methodology.

Therefore, before the alienation of real estate, it is essential to evaluate the factual circumstances of the specific situation, the applicable legal regulation, and the current case law.