Is real estate considered a depreciable asset?

Question

At the following link defining Capital cost allowance, why do they say that a building is a depreciable property:

Capital cost allowance (CCA)

A yearly deduction or depreciation on the cost of certain assets. You can claim CCA for tax purposes on the assets of a business such as buildings or equipment, as well as on additions or improvements, if these assets are expected to last for some years.

In the year you buy a depreciable property, such as a building, you cannot deduct the full cost. However, since this type of property wears out or becomes obsolete over time, you can deduct its capital cost over a period of several years.

Real estate usually goes up in value so why is it depreciable?

Answer 1

Re: "Real estate usually goes up in value" ... yes, the land, primarily.

There's a difference between a building, and the land it is built on. A building won't last forever. Since it doesn't last forever, at some point it will need to be replaced. Depreciation is the accounting & taxation way of recognizing the decreasing value of the asset — the asset being the building, not the land.

Your land is not depreciable. Refer to CRA - Rental - classes of depreciable property. Quote:

Land

Your land is not depreciable property. Therefore, when you acquire rental property, only include the cost of the building in Area A and Area C of Form T776, Statement of Real Estate Rentals. Enter on line 9923 in Area F of Form T776 the cost of all land additions in 2012. For more information, see Area F and Column 3 - Cost of additions in the year. [emphasis mine]

Answer 2

Chris and littleadv have given good answers, but I think the real issue is that you're asking about two different types of values, each is used for a separate purpose:

1) The book value of an asset on a company's financial records, and

2) the market value of a property.

With your question "Real estate usually goes up in value so why is it depreciable?" You're thinking about the second 'market value' that people think about for a property. Over time, the market value of a property--what you could sell it for to someone else--will (generally) increase. This value will have some consideration for the building, some consideration for the land, and some consideration for any other rights or liabilities that come with a particular property. All of these factors can go up or down--but tend to go up.

In your question and link about a Capital Cost Allowance, you are looking at the book value of an asset. Accounting standards usually require that revenues and expenses be recorded during the period in which they were incurred.

If you didn't have it set up this way, then when a company made a major investment it would look like the company had a REALLY bad year. If a company usually earned $100,000 in a year and paid $1 million for a new facotry building (which they could truthfully afford), it would look like they lost -$900,000 in the year the factory was purchased.

So major capital expenditures are set aside on a company's balance sheet and then expensed a little bit at a time according to accounting rules. The process for doing this is called depreciation. This makes it so that all companies will have financial documents that can be compared to each other.

I think it's important to clarify this because other answers are a bit unclear and suggest that any increase in the value of a property would come from the land increasing in value. That's not the case.

(If you want to get really technical, the rule that revenues and expenses match the period that they are incurred in is called the Revenue Recognition Principle and it's common across US GAAP and International IFRS rules)

Answer 3

Depreciation is spreading the purchase expense over a period of time. This is not about the appreciation/depreciation in value, this is about the tax/accounting treatment of the asset.

Real estate is a capital asset and is depreciable. I.e.: you depreciate its costs over a period of time in your books, instead of expensing it when you purchase it.

For example, consider purchasing a $10 stapler and a $100K condo (excluding land value). In your books, you write down a $10 expense for office supplies for the stapler and you're done. But you depreciate the condo over period of time (27.5 years, in the US), so you only reduce the $100K cost basis by $3636/year (assuming full year depreciation) for the whole period of time. At the end your basis (in the building) is reduced to 0 and you "expensed" the purchase in full. The depreciation period is based on the "useful life" (aka life expectancy) of the asset, and may vary (for example, in the US, residential real estate is depreciated over 27.5 years, but commercial - over 39 years, as commercial buildings are expected to last longer).

This is for business accounting, you depreciate assets used in business. So your condo that you rent out is depreciable, but your primary residence (if you own it) is not.

Answer 4

As Chris said it is the land that generally goes up in value and it is the building which is depreciated and loses value as time goes by.

Picture this: You buy a newly built house for $300,000 where the land value is $100,000 and the newly built house is valued at $200,000. Lets assume the land value increases by an average of 5% p.a., so it would roughly double in value every 15 years.

Scenario 1: Over a period of 30 years you do not spend any money at all on the house nor carry out any maintenance. Your land value has increased to $400,000 after 30 years. Your building on the hand (without any maintenance over 30 year) would be dilapidated and run down. Its value may have reduced to about $40,000, as most people would only buy this house to either knock it down and re-build or to do major renovations to it.

Scenario 2: Over the same 30 years you do minimal maintenance and spend as little money as possible just to keep the house habitable. At the end of 30 years the house has an old and out-dated kitchen and bathrooms, old but clean flooring, and is generally old looking. The land value is once again $400,000 and the house maybe about $80,000. Some investors or first home buyers may be interested in buying this house as they can spruce it up a bit and then rent it out or live in it for the first home buyers. As the house is old looking they would pay less than other newer looking houses in the area.

Scenario 3: This time the owners spend a decent budget on the house to keep it in good condition over the 30 years. After 30 years the house is still sought after as it has been well maintained and may have a value of between $150,000 to $200,000. The land once again is valued at $400,000.

Scenario 4: Over the 30 years the owners have carried out some major renovations, they have added a second story, added extra bedrooms and a second bathroom. The land is again worth $400,000 and the house is now valued at over $300,000 as it is comparable with brand new houses in the area.

Now, unless you spend money maintaining a building, as with any man-made asset, the building will deteriorate and lose value over time. Depreciation takes this into account as an asset is usually depreciated over the asset's effective lifespan. If you make improvements to the building it can increase both the value and lifespan of the building. These improvement can usually also be depreciated.

A Property's Market Value

The market value of a property may not always represent the property's true value, as we are emotional beings. During boom times the market value may be much higher that the true value and during a bust the market value may be considerably lower than the true value. Just like with the stock market, where the market price of a stock can be higher or lower than the stock's true value, the same is true for the property market.

Many people pay way to much for houses during boom times due to them getting too emotionally involved with the house. They fall in love with the house and don't want to miss out buying it, so they pay way more than they initially wanted to pay for it.