A building cost $500,000 to construct. Using the extraction method, if the land value is $150,000 and the property sold for $580,000, what is the indicated depreciation?
Correct Answer
C) $70,000
Why this is correct: The extraction method estimates depreciation by comparing the property's sale price to its cost. First, find the depreciated value of improvements: Sale Price minus Land Value = $580,000 - $150,000 = $430,000. Then, depreciation equals Reproduction Cost minus this depreciated value: $500,000 - $430,000 = $70,000. Why the other choices are wrong: "$430,000" is the depreciated value of the improvements, not the depreciation amount. "$150,000" is the land value. "$80,000" might come from incorrectly subtracting land value from reproduction cost ($500,000 - $150,000 = $350,000) and then finding the difference from sale price. Exam tip: Extraction formula: Depreciation = Reproduction Cost - (Sale Price - Land Value).
Why This Is the Correct Answer
Option A ($70,000) correctly applies the extraction method formula. The calculation starts with the reproduction cost new of $500,000, then subtracts the current value of improvements ($580,000 sale price minus $150,000 land value = $430,000). This gives us $500,000 - $430,000 = $70,000 in total depreciation. The method logically determines how much value the building has lost since construction.
Why the Other Options Are Wrong
Option A: $430,000
This is the current value of the improvements ($430,000), not the depreciation amount. This represents what the building is worth now, not how much value it has lost.
Option B: $150,000
This is simply the land value ($150,000), which has nothing to do with building depreciation and completely misapplies the extraction method concept.
Option D: $80,000
This appears to be the difference between reproduction cost and sale price ($580,000 - $500,000 = $80,000), but this ignores the land value component and doesn't follow the extraction method formula.
EXTRACT the Depreciation
Remember 'EXTRACT': E-xtract improvement value (Sale price - Land), X-amine reproduction cost, T-ake the difference, R-ecord as depreciation, A-lways subtract land first, C-ompare to cost new, T-otal depreciation found.
How to use: When you see extraction method questions, immediately identify the three key numbers: reproduction cost, sale price, and land value. Always subtract land from sale price first, then subtract that result from reproduction cost.
Exam Tip
Write down the extraction formula before starting: Depreciation = Reproduction Cost - (Sale Price - Land Value). This prevents calculation errors and ensures you follow the correct sequence.
Common Mistakes to Avoid
- -Subtracting land value from reproduction cost instead of sale price
- -Using the improvement value ($430,000) as the answer instead of the depreciation
- -Forgetting to subtract land value entirely and just using sale price minus reproduction cost
Concept Deep Dive
Analysis
The extraction method is a technique used to estimate depreciation by working backwards from a known sale price. It assumes that the sale price represents the sum of land value plus the depreciated value of improvements. The method extracts the current value of improvements by subtracting land value from sale price, then compares this to reproduction cost new to determine total depreciation. This approach is particularly useful when you have reliable market data for similar properties and accurate land values.
Background Knowledge
The extraction method requires understanding that total property value equals land value plus depreciated improvement value. Depreciation represents the difference between what it would cost to build the improvement today versus its current contributory value to the property.
Real-World Application
Appraisers use extraction method when analyzing recent sales of similar improved properties to estimate depreciation rates for the cost approach, particularly useful for newer construction where reproduction costs are readily available.
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