This is a disputative question in the minds over many years. Many accountants debate on the increasing value of the property.
It is not a fact that only the value of the buildings increases but it is actually the land component of the property that is not depreciated.
The land asset isn’t devalued, as it has limitless useful life. That makes it remarkable among all assets. Because of this reason, depreciation is prohibited only for lands.
However, almost all fixed assets have a useful life but they do not produce a good income for the organizations. So, they are depreciated during this useful life which decreases the cost of their expenses.
Land has no definitive useful life, so there is no real way to devalue it. Because of a small and inadequate amount of lands, their value keeps increasing with time, whereas the value of other fixed assets decreases.
When someone buys a land with some sort of construction on it, the price will be divided into the land and the construction. In that case, the value of that construction will be depreciated but not the land.
So, the buildings should be depreciated or not? Most of the times, the answer is NO.
The reason is, if the residual value of a building is greater than the carrying amount, the depreciation is determined to the profit or loss which is not allowed.
In such cases, the depreciation value becomes zero. So, this is technically not possible to depreciate buildings. It will only happen if the residual value of a building is less than the carrying amount. Since land doesn’t get “used up” the way that buildings do, you can’t depreciate it.
IRS guidelines and financial accounting rules do not allow land depreciation. You may recover the cost of land when you sell the property. In some special cases, land is depreciated when some area of the land is actually occupied.
For example, we can depreciate the natural resources of the land by calculating through the depletion method. There are four depletion method elements i.e. Acquisition costs, Exploration costs, Development costs and Restoration costs.
Acquisition costs—The cost that obtains the property rights through lease and property payments.
Exploration costs—These costs are expenses incurred in the oil and gas industry. These costs can be capitalized.
Development costs— These are the Intangible costs used in the development purposes such as tunnels, wells and drilling costs.
Restoration costs— The cost of restoring the ownership to its actual state with the origin of natural resources.
Depreciation is essentially an accounting transaction. You don’t need to do anything to the asset to devalue it.
As the asset is used with time, an accounting transaction happens in which a specific measure of the expense of the asset is put into a depreciation expense account, and the underlying expense of the asset is decreased by a similar sum.
Depreciating assets is a critical component in financial planning since devaluation cost helps lower taxable pay. This cost additionally gives a financial incentive since you don’t for it, in contrast to pay rates and different costs.