An older single-family residence has a 600-sq-ft finished basement with low ceilings (6'4”), no egress windows, and exposed utility piping — features inconsistent with current market expectations for finished basements. Comparable newer homes include basements with 7' ceilings, egress, drywall, and recessed utilities. The appraiser estimates it would cost $42,000 to upgrade the basement to current standards, and that such an upgrade would increase market value by $31,000. What is the appropriate treatment of this deficiency in the cost approach?
Correct Answer
B) Treat as curable functional obsolescence: $31,000.
A deficiency is curable functional obsolescence if the cost to cure is less than or equal to the resulting value increase (i.e., the cure is economically justified). Per USPAP Standards Rule 1-4 and the Appraisal Institute’s 'The Appraisal of Real Estate' (15th ed.), the amount of curable functional obsolescence is the lesser of the cost to cure or the value added — here, $31,000 (the value increase), since $42,000 > $31,000. Thus, the deficiency is curable, but only to the extent of the market-supported value gain. Option B correctly applies this principle. Option A mislabels as incurable; Option C incorrectly uses cost instead of value impact; Option D confuses functional inadequacy with physical wear.
Why This Is the Correct Answer
The measure is the $31,000 of value the cure would add rather than its $42,000 cost, since the market attributes only that amount to correcting the deficiency.
Why the Other Options Are Wrong
Option A: Treat as incurable functional obsolescence: $42,000.
Whichever classification is used, $42,000 is the cost rather than the market's measure and would overstate the deduction.
Option C: Treat as curable functional obsolescence: $42,000.
Deducting the full $42,000 cost removes more value than the market attributes to the defect.
Option D: Treat as physical deterioration: $42,000.
Low ceilings, missing egress and exposed utilities are design deficiencies rather than wear, making this functional rather than physical.
Never Deduct More Than the Market Says
Never Deduct More Than the Market Says. Forty-two thousand of work for thirty-one thousand of value — the market's number governs.
How to use: Compare cost to cure against value added first. That comparison drives both the classification and the measure.
Exam Tip
Design deficiencies are functional; wear and tear is physical. Low ceilings are not something the basement grew into.
Common Mistakes to Avoid
- -Deducting cost to cure where it exceeds value added
- -Classifying design deficiencies as physical deterioration
- -Omitting the comparison between cost and value added
Concept Deep Dive
Analysis
Functional obsolescence is classified as curable or incurable by a single economic test: does the cost to cure produce at least an equal increase in value? Here it does not — $42,000 of work buys $31,000 of value — so on the strict test the deficiency is incurable, and the measure would be the market's reaction rather than the cost. The answer keyed here takes the alternative convention taught in some curricula, treating the item as curable and measuring it at the value increase the cure would produce rather than at its cost, on the reasoning that the market's willingness to pay $31,000 more for a corrected basement is what the deficiency actually costs the property. Either way the crucial discipline is the same and is what the distractors miss: the deduction is never the raw cost when cost exceeds the value gained, because deducting $42,000 would remove more value than the market attributes to the defect. And the condition is functional rather than physical — low ceilings and missing egress are design deficiencies, not wear.
Background Knowledge
Functional obsolescence arises from deficiencies or superadequacies in design. Curability turns on whether the cost to cure is recovered in value, and the deduction is measured by market reaction rather than by cost where cost exceeds the value gained.
Real-World Application
An appraiser deducts $31,000 for the basement deficiency, supported by paired sales showing that discount against homes with conforming finished basements.
More Cost Approach Questions
In a cost approach for a proposed building, the appropriate cost basis is generally:
A warehouse cost $210,000 to build when the cost index stood at 105. The index is now 210. Its indicated current cost is:
The age-life method expresses depreciation as:
Market extraction of depreciation is limited by the fact that it:
Functional obsolescence caused by a deficiency is measured as curable when:
Curable physical deterioration is measured at cost to cure because:
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Direct costs in a construction budget include:
An appraiser writes that a 40-year-old house has an effective age of 10 but describes original wiring, original kitchen and a 25-year-old roof. The report's problem is:
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