Depreciation

Key Takeaways

• In appraisal, depreciation is loss in value from any cause, measured against what the improvement would cost new today.
• The three classes of depreciation are physical deterioration, functional obsolescence, and external obsolescence.
• Depreciation applies to the improvements, not to the land, which is valued separately and added back in the cost approach.
• Curable and incurable describe whether the cure returns at least what it costs, not whether the repair is physically possible.

What It Means

Depreciation in appraisal is loss in value, whatever the cause of it. The appraiser starts with what the improvement would cost to build new today, then subtracts everything that makes the actual building worth less than that figure. The total subtracted is accrued depreciation. It attaches to the improvements. Land is valued on its own and is not depreciated, which is why the Cost Approach adds land value back at the end.

The causes sort into three buckets. Physical Deterioration is wear and tear on the structure: a spent roof, a cracked driveway, tired paint, a furnace near the end of its life. Functional Obsolescence is a defect in the building's own design, such as four bedrooms served by a single bathroom, or a bedroom you can reach only by walking through another bedroom. External Obsolescence comes from beyond the property line, such as a new freeway on ramp at the corner or the closing of the mill that employed the town.

Each cause is then judged curable or incurable, meaning whether fixing it returns at least as much value as the fix costs. That is the question a seller is really asking when they ask whether to replace the roof before listing, and it is why the appraisal sense of depreciation shows up in ordinary listing conversations.

How It Works in Washington

In Washington, the appraisal sense of depreciation is written into the property tax statute. RCW 84.40.030 requires all property to be valued at one hundred percent of its true and fair value in money, and it tells the assessor how to get there. Sales of the property being appraised or of similar properties within the past five years are the primary evidence, and consideration may also be given to cost, cost less depreciation, reconstruction cost less depreciation, or capitalization of the income a prudent use of the property would produce. The same section directs the assessor to determine the true and fair value of the land exclusive of the structures on it and the value of the structures separately, which is the identical split the cost approach uses when it depreciates the building and leaves the ground alone.

Who may prepare a formal appraisal is a separate question in Washington. Chapter 18.140 RCW governs state certified and state licensed appraisers, and RCW 18.140.020(6) allows a licensed broker to issue a brokers price opinion while barring it from being used as an appraisal in a federally related transaction. So a broker can tell a seller that a 1970s kitchen and a failing roof are costing the house value; measuring accrued depreciation inside an appraisal report is appraiser work.

Example

An appraiser values a 1968 rambler in Yakima using the cost approach. Replacement cost new for the house comes to $340,000. She then measures accrued depreciation in three parts:

• Physical deterioration, $46,000 for a roof, furnace, and exterior paint that are all at the end of their useful lives.
• Functional obsolescence, $22,000 for four bedrooms served by one bathroom, with no place to add a second bath without giving up a bedroom.
• External obsolescence, $18,000 because an arterial widening now runs 40 feet from the front window.

Accrued depreciation totals $86,000, so the depreciated value of the improvements is $254,000. The land is valued separately at $95,000 from recent vacant lot sales and takes no depreciation at all. The cost approach indication is therefore $349,000. The $18,000 of external obsolescence is incurable because the owner cannot move the road, while most of the $46,000 in physical deterioration is curable: replacing the roof and furnace before listing should return at least what it costs.

Common Mistakes and Exam Traps

• Depreciation in appraisal is loss of value from any cause, while depreciation in income tax is a deduction that recovers the cost of property over time. A valuation question means the appraisal sense.
• Land is not depreciated. Only the improvements lose value in the cost approach, and land value is added back separately.
• Physical deterioration is wear on the building, functional obsolescence is a flaw in the design, and external obsolescence comes from off the property. A location problem is never functional obsolescence.
• Curable versus incurable turns on whether the cure pays for itself in added value, not on whether a contractor could physically do the work.