Depreciation of Property, Definition, Tips to calculate, a complete guide
Consider that you are a seller of property. You want to know an apartment’s resale value. The apartment is located on the southern side of the city and has aged 10 years. You also want to know about the building’s depreciation value, keeping in mind, the age of the property, which could affect the total value of the property.
Though where a property is located can majorly change the sale price, specific physical aspects like the property’s age are also crucial in determining the total value of the property – this is important both for the seller and the buyer for getting a good deal. Building wears down with time and age and that is something that cannot be avoided. There is a direct connection between property value and the physical life of a structure.
With time, a property depreciates but the land is an asset that remains valuable for many years and therefore, its value does not depreciate.
Depreciation of property is the reduction in the sale value of a house. This depreciation is calculated as the ‘factor’ product of the total property value with the construction age. This factor is valid only for housing structures and not the land on which they are built. So, the value of the land remains constant and is benchmarked to the market value, while the cost of construction for the building is calculated on the basis of the building’s total life and the current age.
Construction will always depreciate while land appreciates. When you invest in a property in India, you are also purchasing the land’s FSI on which the project has been built. The reason why Selling a Property, that is, resale flats fetch higher prices than the buying cost is because the land appreciation is factored in. In the case of independent houses, the building part depreciates while the land has the value of the market price.
Types of Depreciation
Straight-Line Depreciation: This is the simplest method where the same amount of depreciation is deducted from the asset’s value each year. It spreads the cost evenly over the asset’s useful life.
The formula for straight-line depreciation is:
Depreciation Expense = (Cost of Asset – Residual Value) / Useful Life
Declining Balance Depreciation: This method deducts a fixed percentage of the asset’s value each year. As the asset gets older, the depreciation amount decreases because it’s based on the remaining book value.
The formula for declining balance depreciation is:
Depreciation Expense = Book Value of Asset × Depreciation Rate
The depreciation rate is usually a multiple of the straight-line rate (e.g., 2 times the straight-line rate).
Sum-of-the-Years’ Digits (SYD) Depreciation: With this method, more depreciation is taken in the early years and less in the later years. It adds the digits of the asset’s useful life and uses that to calculate the depreciation amount.
The formula for SYD depreciation is:
Depreciation Expense = (Remaining Useful Life / Sum of the Years’ Digits) × (Cost of Asset – Residual Value)
The Sum of the Years’ Digits is calculated as the sum of the digits from 1 to the asset’s useful life (e.g., for a 5-year asset, the sum would be 1 + 2 + 3 + 4 + 5 = 15).
Units of Production Depreciation: This method links the depreciation to the actual usage or production output of the asset. The more the asset is used, the more it depreciates.
The formula for units of production depreciation is:
Depreciation Expense per Unit = (Cost of Asset – Residual Value) / Total Units of Production
Depreciation Expense = Depreciation Expense per Unit × Units Produced in the Current Period
Double Declining Balance (DDB) Depreciation: This is an accelerated method where a higher depreciation rate is used initially, gradually decreasing over time. It’s useful for quickly writing off assets in the early years.
The formula for DDB depreciation is:
Depreciation Expense = Book Value of Asset × 2 × (Straight-Line Depreciation Rate / Useful Life)
Tips for Calculating Depreciation
The average lifespan of any building, for an independent house, is 60 years. Subtract the ratio of construction years and total building age to calculate the depreciation of the building part. For example, if a buyer is selling his or her property after 15 years of construction, the selling price would use the formula:
Number of years after the building construction: Total building age = 15:60 = 1:4
The remainder of the useful age would be the real selling price of the construction. Now, add the land’s market value to this price to get a reasonable selling price for a Property for Sale in Gurgaon or anywhere else.
The depreciation factor can become void and null if there is a lot of demand for the location and land is scarce. The obsolescence factor is another factor that further affects the cost of a house. This means elements that can become obsolete like plumbing, electrical fitting, type of construction, interiors, design, and so on.
Functional obsolescence means that your house is either too grand or showy for the locality or does not meet the standard of other properties in the same area. Open wiring is a simple example of this. It is an old and outdated feature and can cut the selling prices of the house.
Another scenario is when a buyer wants to purchase a property because there is an emotional reason. For example, you might have spent your childhood in House XYZ, which got sold for some reason. Now, you have the means to buy it back, and you may be willing to pay a higher price for it. This is an exception as well and cannot be considered as a benchmark for the market.
If you are a seller, then try not to overprice your property. An old property may need renovation and repair work, and a buyer would be spending a minimum of 5% of the property cost for that task. Therefore, it is logical to offer a reasonable selling price, or you can renovate the house yourself and then sell it at the original price.
Now that you know about depreciation price your property accordingly if you are a seller, and look for depreciation factors if you are a buyer.