In accounting an asset is subject to depreciation as it loses value over time or becomes obsolete. But does land depreciate in value? And what is the depreciation rate for land? If you own land this is something you may be worried about.
We look at land value depreciation and what the accounting effect may be by using some examples to illustrate this.
Does Land Depreciate In Value?
Land cannot depreciate in the accounting sense as land does not have a ‘determinable usable life’ according to the IRS. Despite being a tangible asset, land cannot be depreciated as its physical condition cannot deteriorate.
As it is not possible to determine land’s usable life it cannot be said to depreciate. For this reason it is almost impossible to calculate land depreciation.
Despite this, the value of land does fluctuate, but this is due to external factors not to the land’s inherent condition.
Other long term tangible assets such as buildings or vehicles can depreciate in value as their usable life is determinable. This is an essential element for any asset to be depreciable.
For example, a company vehicle is subject to depreciation as its condition will deteriorate over time. Paintwork may corrode, mechanical parts may fail and this is how a vehicle’s depreciation will be assessed for accounting purposes.
The same process cannot be applied to land as its physical condition remains the same. It does not get worn out or become obsolete.
While the value of land is not constant, and may go up or down according to market conditions, value decline does not qualify and is not the same as depreciation.
Land Value Depreciation Examples
Below are two examples of how land value can change but still not count as depreciation.
In 2002 a plot of land was worth $300,000. Over two years the value of the land increased steadily and in 2004 the same piece of land was worth $350,000. A property boom in the area in 2006 pushed the value of the land up to $500,000.
Then in 2008 the associated property crisis pushed the value back down to $250,000.
In the above example the value of the land fluctuates with external influences and factors. From an accounting point of view if the value of an asset reduces in a given period of time then it can be included in a calculation of depreciation.
However, land is said to have an infinite usable life and therefore cannot be depreciated. In this sense it is unique as an asset as it is the only asset for which depreciation is not permitted.
Our second example deals with the condition of the land itself rather than with market conditions.
In 2005 a piece of marshy land was unused. In 2008, it was converted into usable land by the addition of sand and other materials. The value of this plot of land went up, and it was in high demand.
As developments were going up so was the value of the land. However, in 2010 the area experienced an earthquake and the whole development was destroyed.
The piece of land was left in an unusable condition. Consequently, the value of the land dropped drastically.
This example shows that although land is vulnerable, value cannot be equally and periodically reduced over time. It is apparent that land does not have its own particular useful life.
The earthquake which occurred in 2010 was the reason for the decline in the land’s value just as the market influenced the rise in early 2008. These events could have occurred at any other time.
In accounting, it is only possible to calculate the depreciation of an asset which has a particular value at the beginning of its useable life. This value declines over time and this is why land does not qualify for depreciation.
Accounting Effects For Changes In Land Value
It is obvious that the value of land can change over time for many reasons. As in the example, events can both increase or decrease the value of land, but a decline in value does not mean that there is depreciation.
When agricultural land is impacted by something external like a natural calamity that renders it unusable for agriculture its value will drop. This does not mean that the drop in value can be called depreciation.
First because the event was unpredictable and secondly because the reduction in value was dependent on an external force. Finally, there is no way to predict that another event will occur that will make the value of the land increase.
Because all these fluctuations are caused by outside influences the changes in value cannot be called depreciation.
Taking A Loss
If a business holds land that has dropped in value it can write off the decline but only when the land is sold. For example, a plot of land that is worth $10,000 has reduced in value, but the business cannot claim it as a depreciation expense because land is not depreciable.
However, if the land is subsequently sold for $8,000 then the business can claim the $2,000 as a capital loss in the same year that it sells the land.
Why Land Does Not Depreciate
All fixed assets have a useful life after which they no longer contribute to or stop making money for a business. While they are contributing during this useful life these assets are depreciated.
This means that an asset’s cost is reduced as it deteriorates to what it is worth at the end of its useful life.
As land has no defined usable life and is deemed to have an unlimited life span this process of reducing its cost does not apply. Furthermore as it is not possible to create new land, as land is used up and becomes scarce the price will continue to increase.
Depletion Not Depreciation
The only exception to this rule is when there is a natural resource that is extracted from the land. For example, a mine that has had its ore reserves emptied.
For this example, depreciation is applied to the natural resources using the depletion method. Depletion is the yearly charge for the use of any natural resource. To calculate the depletion rate you need to calculate the depletion base or amount of depletable asset.
This includes acquisition, extraction, development and restoration costs. The depletion base less its salvage value is charged to depletion expense in each period.
What Is The Depreciation Rate For Land? – Frequently Asked Questions
Why Does Land Not Depreciate In Value?
Land that is used in a business is a tangible asset. It is therefore assumed to have an unlimited life. This is not the same as land that is an investment or sold by a real estate developer.
What Causes Land Depreciation?
Land cannot depreciate in the majority of cases. However, degradation caused by erosion, zoning changes or improper use may cause land to depreciate.
Land is deemed to have an infinite useful life and as such cannot be depreciated. Although its value can decline as a result of external forces this does not qualify as depreciation.
We hope this guide to land depreciation has been helpful.
Paul Martinez is the founder of BendingDestiny.com. He is an expert in the areas of finance, real estate, and eCommerce.
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