Understanding Depreciation of Land and Building: How It Impacts Property Values

When the prices of immovable assets are often estimated or calculated, depreciation is also considered. The term depreciation indicates how much the property's value has reduced over time. In this blog, we will understand depreciable properties, how the depreciation of land and buildings is governed by acts, and how it must be considered for investments. 

What is a Depreciable Property?

Any immovable asset that can depreciate over time owing to usage, everyday wear, ageing, or damage is considered a depreciable property. It is set by the Income Tax Department and is often used for business purposes. Some examples of depreciable properties include vehicles, machines, buildings, and electronics. 

Is Land a Depreciable Property?

Land is an exceptional immovable asset. This is because depreciation in land is prohibited. It is believed to have an infinite, useful life, making it the most unique, immovable asset.

How is Depreciation of Depreciation of Land and Buildings Calculated? 

For instance, a family plans to sell their 5-year-old home. 

Hence, the age of the structure is 5 years. When they made the purchase, the land value was ₹50 lakhs. The construction cost was ₹75 lakhs. The appreciated land value is ₹30 lakhs. The total useful age of the same is 60 years.

Now, the depreciated value of the property will be the age of the structure / total useful age = 5 years/60 years = 1/12

Now, the depreciated value will be removed from the construction cost of the property = Construction Cost- Depreciated value = ₹75 lakhs * (1/12) = ₹6.25 lakhs.
To this, the appreciated land value will be added, which is = ₹30 lakhs + ₹6.25 lakhs = ₹36.25 lakhs (final market value that can be quoted by the family for selling their property)

Why are Depreciation Rates Significant?

Depreciation rates are announced by the Income Tax Department every financial year (FY). They let taxpayers claim deductions based on reducing the value of both tangible and intangible assets. However, it must be noted that the rates for building depreciation have not changed since FY 2018-19. Generally, the annual depreciation rate is set at 5% for residential building use, whereas for commercial building use, it is 10%. For temporary wooden structures, the depreciation value is 40%. 

Factors that impact the Calculation of Depreciation

Location

Location is critical in determining the depreciation of an asset. The place where a building sits or a land parcel sits influences the pricing of the same. The connectivity and accessibility to basic amenities directly affect the overall value.

Physical Obsolescence

This means that some parts of the asset, the building, stop serving their designated purpose the way they used to. This is directly related to the building age, which can lead to structural damage or deterioration in the property. Even a chipping wall paint is an example of this. Such physical deterioration results in a reduction in the value of the building, too.

The useful life of the asset

The time period for which the given asset can be used is called the useful life.

What is the Land and Building Depreciation Rate as per the Companies Act? 

• Depreciation as per the Companies Act 2013 applies for FY 2014-15 and after that. The same became applicable from 1 April 2014. Here are a few essential points stated by the same.
• Depreciation is calculated by considering the asset's useful life, cost and residual value.
• Any method between the Written-Down Method (WDV) or the Straight Line Method (SLM) can be used for calculating depreciation. Whichever of these methods is applied must be shown in accounts.
• A specific Schedule – II states that class-wise assets and their residual values shall not exceed 5% of the asset's original cost. However, companies can adopt a useful life that differs from the same. However, they must necessarily mention the same and provide justification for this in their financial statements duly backed by technical advice. This helpful life must only be disclosed if it is taken differently from Schedule II.
• When an asset is purchased or sold, the calculation will be made as per the date of purchase or sale.
• For holdings in which NESD (No Extra Shift Depreciation) is mentioned, the depreciation will remain the same irrespective of the work shifts.
• For assets other than this, if the asset is used for double shifts during any time of the year, the depreciation increases by 50%. Similarly, for triple shifts, it is increased by 100%.
• For factory buildings, the useful life per the Companies Act is 30 years, and the WDV and SLM rates are 9.50% and 3.17%, respectively. Similarly, for buildings other than factory buildings with an RCC Frame structure, the useful life is 60 years, and the depreciation rates for WDV and SLM are 4.87% and 1.67%, respectively. For buildings other than factory buildings but with non-RCC frame structures, the useful life is 30 years, and the WDV and SLM rates are 9.50 % and 3.17%, respectively. For fences, wells and tube wells, the useful life is 5 years, whereas for other temporary structures, it is 3 years. Similarly, the act mentions the useful life, WDV rate, and SLM rate for bridges, culverts, bunkers, roads, plants, machinery, furniture, fittings, motor vehicles, laboratory equipment, office equipment, computers and data processing units.  

Conclusion

The depreciation of land and buildings is different since both are immovable assets, but the ground is an exceptional asset depreciation, which is prohibited.  
Depreciation is determined by the value of an asset and its useful life. Factors influencing the depreciation value include building use, locality, location, available infrastructure, and physical obsolescence. For the best long-term investments, buyers must make sure to take all these aspects of valuation into consideration. Similarly, owners planning to sell out their properties must calculate values using the abovementioned method to quote fair prices.