In the extraction method of estimating depreciation, if the land value is $200,000, the sale price is $750,000, and the replacement cost new is $800,000, what is the amount of depreciation?
Correct Answer
D) $250,000
Why this is correct: The extraction method estimates depreciation by comparing the depreciated building value from a sale to its replacement cost. First, find the building value indicated by the sale: Building Value = Sale Price minus Land Value = $750,000 minus $200,000 = $550,000. This is the depreciated value of the building. Then, depreciation is the difference between the cost to build it new and its current value: Depreciation = Replacement Cost New minus Building Value = $800,000 minus $550,000 = $250,000. Why the other choices are wrong: "$550,000" is wrong; this is the building value, not the depreciation. "$50,000" is wrong; this is the difference between replacement cost and sale price, incorrectly ignoring the separate land value. "$600,000" is wrong; it results from an incorrect calculation like Sale Price minus Replacement Cost. Exam tip: In extraction, always isolate the building value first (Sale Price - Land Value) before calculating depreciation (RCN - Building Value).
Why This Is the Correct Answer
Option A ($250,000) correctly applies the two-step extraction method formula. First, the building value is extracted from the sale: $750,000 sale price minus $200,000 land value equals $550,000 building value. Second, depreciation is calculated as the difference between replacement cost new and the extracted building value: $800,000 minus $550,000 equals $250,000 in total depreciation. This represents the market's perception of how much value the building has lost from all forms of depreciation.
Why the Other Options Are Wrong
Option A: $550,000
Option A ($550,000) represents the extracted building value, not the depreciation amount. This is the intermediate calculation step where land value is subtracted from sale price, but it's not the final answer for depreciation.
Option B: $50,000
Option B ($50,000) incorrectly calculates depreciation as the difference between replacement cost new and sale price ($800,000 - $750,000), which ignores the land value component and doesn't properly extract the building value first.
Option C: $600,000
Option C ($600,000) appears to subtract the land value from replacement cost new ($800,000 - $200,000), which has no logical basis in the extraction method and doesn't follow the proper sequence of calculations.
SLRD Formula
Sale price minus Land value equals Remaining building value, then Replacement cost minus Remaining building value equals Depreciation. Remember: S-L=R, then R-R=D (SLRD).
How to use: When you see an extraction method problem, immediately write down SLRD and fill in: Sale price - Land = Remaining building value, then Replacement cost - Remaining building value = Depreciation. This ensures you follow the correct two-step sequence.
Exam Tip
Always perform the extraction method in exactly two steps and double-check that your depreciation amount is logical - it should be less than the replacement cost new and the building value should be positive.
Common Mistakes to Avoid
- -Subtracting land value from replacement cost instead of sale price
- -Using the extracted building value as the final depreciation answer
- -Forgetting to perform the two-step calculation sequence
Concept Deep Dive
Analysis
The extraction method is a technique used to estimate depreciation by analyzing actual market sales data. It works by extracting the building value from a comparable sale (by subtracting land value from total sale price) and then comparing this extracted building value to the replacement cost new. The difference between what the building is worth in the market versus what it would cost to build new represents the total depreciation from all causes. This method is particularly useful because it reflects actual market perceptions of depreciation rather than theoretical calculations.
Background Knowledge
The extraction method requires understanding that real estate consists of land and improvements, and that depreciation only applies to the improvements (building). Appraisers must be able to separate land value from total property value to isolate the building component for depreciation analysis.
Real-World Application
Appraisers use the extraction method when they have good comparable sales data and reliable land values, often in residential appraisals where recent sales of similar properties provide market evidence of how much depreciation buyers are recognizing in the marketplace.
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