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Methods for Estimating Property Depreciation

Instructor: Eileen Cappelloni

Eileen worked for the Orange County Asssociation of Realtors for 31 years. She has written real estate courses and exams for other publishing companies

In this lesson, you will learn how to identify and describe methods for estimating accrued property depreciation (e.g. straight-line method of calculating depreciation) and learn how to estimate depreciation.

What Is Depreciation?

David Thornton bought a home in New York in 1987. He paid $200,000 for it. When he reached retirement age in 2014, he decided to sell this house and move to a warmer climate. He purchased another home in Florida, and put the New York house on the market. Three months later, he realized that the house just wasn't going to sell quickly, and he thought about renting it out instead.

He was concerned, however, about claiming income from the rent he would be charging. David's accountant advised him that although he would need to claim the income from the rental, he would be permitted to deduct most expenses incurred in maintaining or repairing the house. Additionally, the home's value would be considered to have diminished each year by using a pre-determined formula called depreciation.

Types of Depreciation

There are several types of depreciation:

  • Physical deterioration is loss in value due to normal wear and tear, or from negligence, damage or aging of the structure. Physical deterioration can be curable or incurable. To determine whether or not it's curable becomes a matter of cost. If fixing or replacing a broken fireplace, for example, would add as much or a higher value to the property, then it's curable. If it isn't, or it doesn't add to the value, then it is incurable.
  • Functional obsolescence can be caused by either an over-improvement or a deficiency in either the structure or design of a building. An example of these could be a four-bedroom home with one bathroom, or a $30,000 pool in the backyard where the market may be only willing to pay $10,000 for that feature.
  • External obsolescence is a loss in the market value of a property that is caused by external factors that are outside the physical borders of the subject property. It is generally incurable in that you can't pick up the house and move it to another area that does not have the problems or blight that has caused the property to lose value. Examples might include a sewerage treatment plant near the property.

Accrued depreciation is the total depreciation of a building from all causes: normal wear and tear, the quality of the original construction, and the level and type of ongoing maintenance and repair.

Straight Line Depreciation

The simplest, although not the most accurate, method to determine depreciation is called straight line depreciation. It is simply depreciating real property annually in equal amounts over a predetermined life span.

The appraiser estimates the approximate total number of years a structure should contribute value above the value of the land (and land is never depreciated), and that total number of years is considered to be 100% of its useful life. The expert then estimates the total life of the building lost by depreciation, and this is called its effective age. The effective age is divided by the total life to achieve the percentage of accrued depreciation over the total economic life of the building.

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