Land is an asset of the company which is having the unlimited useful life, therefore, no depreciation is applicable to the land unlike the other long term assets such as buildings, furniture, etc which have the limited useful life and hence their costs to be allocated to the accounting period in which they are of some use to the company.
Does Land Depreciate?
Land, although a tangible fixed asset, does not depreciate. Land cannot get deteriorated in its physical condition; hence we cannot determine its useful life. It is almost impossible to calculate land depreciation. The value of land is not constant on a long-term basis – it may enhance or may as well deteriorate. In other words, it is fluctuating. Hence, it gives an uncertain picture of the asset value, which is why calculations are difficult.
Land Depreciation – Example #1
In a hypothetical example, a value of a particular piece of land is $300,000 in the year 2002. After 2 years, the value increases steadily and goes up to $350,000. Due to the real estate boom in the location during 2006, the value goes up to $500,000 (prices shooting up on the graph). However, due to a crisis in 2008, the value then goes down to $250,000 (nearly half in 2 years). If a graph is drawn for these values it would be like:
In this case, the value of land fluctuates. Understanding from depreciation point of view, an asset whose value reduces within a given of period of time, can be used for calculating depreciation.
Land Depreciation – Example #2
A piece of land was a marshy area in 2005. It was converted into a usable land in 2008 when real estate products were at their peak, by dumping sand and other material and were turned into a solid lot of land. The value of this piece went up manifold, and the land was in great demand. As and how developments were done, the property prices went up and up. In 2010, unfortunately, the land was hit by an earthquake and the entire development made over the land was devastated. The land itself got worn out in a manner that was unable to be used again. In this case, the land value dropped down drastically. This shows that although the land is vulnerable, its value cannot be periodically and equally reduced over time. Moreover, understanding with this example, we can say that land does not have its own particular useful life. It was due to the earthquake in 2010 (which may have occurred in any other year later or earlier), that the value went down; or the development made in 2008 due to which its value rose high.
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In accounting practices, depreciation can be calculated only for those items which have a particular value at the beginning of their useful life, and that particular value deteriorates over a period of time. This is the reason, why “land” does not qualify for depreciation.
Accounting Effects for Change in Values of Land
The value of land can change over a period of time.
- As per the above example, say the land is worth $1 million in 2015. If there are developments in the location which are beneficial for the value of the area, a value of this piece of land goes up to $1.5 million in 2018.
- On the other hand, if the same piece is agricultural land, and if there are natural calamities in the location due to which agriculture is unfavorable in the future, then its value goes down considerably. However, this loss in value cannot be termed as depreciation, one because it is unpredictable, second because it depends on an external force.
- Thirdly, it may happen that value may again go up due to some other external factor. Hence, it is not right to call this change in value as a part of depreciation.
- The reduction in the value of land can be claimed only at the time of sale. If the landowner simply holds the asset, then change in value will not affect or get claimed in any way. However, at the time of sale, if the value increases, then profit can be claimed under capital gain, and vice versa the reduced value is claimed as a capital loss. Although land itself cannot depreciate, the assets which lie on such land can always qualify for Land depreciation, and even though these other assets may be a cause for deterioration of the land value, they hardly have any significance over the depreciation aspect of this land.
- On the other hand, if the land needs improvements for such other assets, the cost of such improvements can also qualify for land depreciation. For example, If the land serves as a dumping ground currently, and a developer wishes to construct a building over this land, there will be rubbish removal charges to the developer. This can be a lot of expense for him, and so he may opt for depreciating this expense over a period of time. This may be a capital improvement for the building going to be constructed, and so can be amortized over a period of time.
Hence, the land per se does not have any effect of depreciation, although the value of such land grows manifold after the building gets constructed.
Final Thoughts on Land Depreciation
Depreciation is an important calculation in accounts. The amount, which is deducted from the value of any tangible asset in cash flow or a balance sheet at any point in time, can be claimed as a non-taxable item. As it gets reduced from the value of the asset, the tax which is calculated on revenue after all deductions and/or additions excludes depreciation.
However, everything said and done, it is important to understand that “Land does not depreciate”. When we use the term depreciate here, we sincerely refer to the accounting term “depreciation”. In a literary sense, it does depreciate, meaning, there may be deterioration in its value, however, from an accounting point of view, we cannot pass any entries in the system for such deterioration in the name of depreciation.
In this article, we answer the question – Does Land Depreciate? Here we discuss land depreciation with examples and accounting effects with the changes in the value of land. You may learn more about accounting basics from the following articles –