Depreciation in appraisal differs from depreciation in accounting because appraisal depreciation:
Correct Answer
C) Measures actual loss in value from all causes
Why this is correct: Appraisal depreciation measures the actual loss in value from all causes (physical, functional, external) as of the effective date, based on market evidence. It is not a scheduled formula. Why the other choices are wrong: Appraisal depreciation applies to any age property. It does not follow tax schedules. The two systems calculate depreciation differently. Exam tip: Appraisal depreciation is market-derived loss; tax depreciation is a formula.
Why This Is the Correct Answer
Measuring actual loss in value from all causes is what distinguishes appraisal depreciation, and both halves of that phrase matter. It is a loss in value rather than an allocation of cost, and it is from all causes rather than from age alone, which is why functional and external obsolescence sit alongside physical deterioration. The measurement is tied to the effective date and to the market rather than to a schedule, so an appraiser supports it with evidence such as extraction from comparable improved sales or an effective age drawn from observed condition and market behavior. In the cost approach the depreciation estimate is frequently the weakest link, which is why the approach loses reliability as improvements age and why the report should explain how the depreciation was derived rather than simply stating a percentage.
Why the Other Options Are Wrong
Option A: Applies only to the first five years of ownership
Depreciation applies throughout an improvement's life, and older buildings typically exhibit more of it rather than less, so a five-year window has no basis in either system. Accounting depreciation runs over a statutory recovery period measured in decades for real property, and appraisal depreciation is measured whenever the cost approach is developed. Candidates pick this by half-remembering that early years matter in accelerated tax methods, which is about the rate of write-off rather than about when depreciation exists.
Option B: Follows a schedule set by tax regulations
Following a tax schedule is exactly what appraisal depreciation does not do, and it is the definition of the accounting concept the question asks you to distinguish. A statutory recovery period is set by legislation for revenue purposes and reflects no judgment about a particular building's condition, utility, or market environment. This is the answer a candidate gives when the two meanings of the word have not been separated.
Option D: Is calculated identically under both systems
The two systems produce different numbers by design, since one allocates historical cost on a formula and the other measures present value loss from market evidence. They also start from different bases, since accounting depreciation runs on capitalized cost including acquisition while appraisal depreciation runs on cost new as of the effective date. Identical results would be a coincidence rather than a rule.
Loss Measured, Not Cost Allocated
The accountant spreads a number that already happened across future years. The appraiser measures how much value is actually missing today, from wear, from bad design, and from the neighborhood. One is bookkeeping, the other is observation.
How to use: When a stem contrasts the two, answer with loss in value from all causes and market derivation. Options invoking schedules, time windows, or equivalence are each importing the accounting meaning into a valuation question.
Exam Tip
Name the three causes whenever depreciation appears: physical, functional, and external. Many items in this topic turn on recognizing that depreciation is broader than wear and tear.
Common Mistakes to Avoid
- -Carrying a tax or book depreciation figure into the cost approach
- -Treating depreciation as physical wear alone and omitting functional and external obsolescence
- -Stating a depreciation percentage without explaining how it was derived from market evidence
Concept Deep Dive
Analysis
The word depreciation names two unrelated concepts, and confusing them is one of the most common errors carried in from business coursework. Accounting or tax depreciation is a cost recovery mechanism: a taxpayer allocates the capitalized cost of an asset over a statutory life on a prescribed schedule, and the resulting book value has no necessary relationship to what the asset is worth. Appraisal depreciation is a valuation measurement: it is the difference between the cost new of the improvements as of the effective date and their contributory value in their present condition, and it captures every cause of that difference. Those causes group into physical deterioration, functional obsolescence, and external obsolescence, with the first two arising within the property and the third from influences outside it. Because appraisal depreciation is a loss in value, the evidence for it must come from the market, whether extracted from sales, measured through the market extraction method, estimated by the economic age-life method using market-derived effective age and total economic life, or itemized in the breakdown method. A building that has appreciated in an accounting sense being fully depreciated can still exhibit almost no appraisal depreciation, and the reverse is equally possible.
Background Knowledge
You need to know that appraisal depreciation is the difference between cost new of the improvements as of the effective date and their contributory value, arising from physical deterioration, functional obsolescence, and external obsolescence. You should know the methods used to estimate it, including market extraction, the economic age-life method using effective age and total economic life, and the breakdown method, and that each requires market support. You also need to know that accounting and tax depreciation allocate capitalized cost over a statutory life for cost recovery purposes and produce a book value unrelated to market value, and that the cost approach loses reliability as depreciation grows.
Real-World Application
Appraising a thirty-year-old office building whose owner's books show it as nearly fully depreciated, an appraiser estimates cost new, then extracts depreciation from four sales of similar-aged buildings by deducting site value and comparing to cost new, arriving at roughly thirty-eight percent overall. The report separates the physical deterioration evident in the roof and mechanical systems from functional obsolescence in the floor plate layout and from external obsolescence tied to a submarket vacancy rate well above the metropolitan average, and explains that the accounting book value has no bearing on the analysis.
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:
A 2,050 sq ft dwelling is priced at $178 per square foot with a $34,000 detached garage and $21,500 of site improvements. Cost new is:
A house has three bedrooms sharing one bathroom, and adding a second bath is economically justified. This is:
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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