Illinois real estate exam glossary
Cost approach: current cost, depreciation and separate site value
Start with what it would cost to build an equivalent improvement today, not what the owner paid years ago. Then recognize its loss in value and add the separately supported site value. The arithmetic is straightforward; defining each input is where a cost-approach problem can change.
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The short answer
The cost approach estimates a property value indication as site value plus current replacement or reproduction cost of improvements, minus accrued depreciation. If site improvements are handled separately, add their depreciated contribution only when it has not already been included. Value the site separately; do not apply the building's depreciation fraction to it. Current costs, market-supported losses and the scope of each input matter more than the apparent precision of the formula.
Reviewed for October 2026. PSI places the cost approach at national III.B.3, within Valuation's eight of the 100 scored national broker questions. There is no separate published cost-approach quota. Examples use stated assumptions and are original teaching material, not appraisals, contractor bids, insurance estimates or tax calculations.
Five steps to a cost-approach indication
- Define the assignment and components. Identify rights, the effective date and the value premise. Mark whether cost new includes the building only or all improvements, and whether site development, landscaping or other additions are already included.
- Estimate the site separately. Use relevant evidence for the site as though vacant under the appropriate highest-and-best-use premise. An old purchase price or assessed allocation is not automatically its current market indication. Adverse site influences can affect its value.
- Estimate current cost new. Choose replacement for equivalent modern utility or reproduction for a replica. Include the applicable direct and indirect costs and market-supported entrepreneurial incentive, with clear boundaries so costs or profit allowances are not added twice.
- Measure accrued depreciation. Consider physical deterioration, functional obsolescence and external obsolescence. Use the stated supported method, such as a simplified age-life ratio, breakdown analysis or market extraction. Do not subtract a loss already addressed by another input.
- Assemble and test. Subtract improvement depreciation from matching improvement cost. Add site value and any separately excluded site-improvement contribution. Reconcile the indication using the evidence and applicable assignment requirements rather than treating cost as guaranteed value.
| Component | Treatment | Check |
|---|---|---|
| Site value | Separately supported current site indication | Can include adverse site influences; no building age-life fraction |
| Improvement cost new | Current replacement or reproduction basis | Identify direct, indirect and entrepreneurial components already included |
| Accrued depreciation | Deduct supported loss from the corresponding improvements | Physical, functional and external loss without duplication |
| Separate site improvements | Add depreciated contribution only if excluded elsewhere | Paving or a fence can wear out; the same item must not be added twice |
| Property indication | Site + depreciated improvements + excluded separate items | A value indication, not guaranteed price or a construction invoice |
The distinctions that matter
| Distinction | How it works | What to notice |
|---|---|---|
| Replacement and reproduction | Replacement estimates equivalent utility using modern design, materials and methods. Reproduction estimates a replica of the existing improvement. | A modern substitute need not duplicate an obsolete layout. Reproduction of an old feature does not prove buyers value it at its construction cost. |
| Current cost and historical cost | Cost new is tied to the effective date. A historical invoice needs credible updating and analysis before it can support a current estimate. | A $200,000 invoice from decades ago is not automatically current cost new or current value. |
| Physical, functional and external loss | Physical deterioration is wear or damage. Functional obsolescence concerns internal design or utility. External obsolescence comes from outside influences. | Physical and functional losses can be economically curable or incurable. External loss is generally incurable by the owner, even if the external condition is temporary. |
| Effective age and chronological age | Chronological age is elapsed calendar time. Effective age reflects condition, utility and maintenance in comparison with competitive improvements. | Renovation can affect effective age without changing the original construction date. A new roof does not automatically make the whole building brand new. |
| Total life and remaining life | Total economic life is the full period of value contribution; remaining economic life is the portion still ahead. Physical survival can be longer than economic usefulness. | For a stated simple age-life model, effective age / total economic life is the depreciation fraction. If given effective age and remaining life, first add them to obtain the model's total. |
| Entrepreneurial incentive and profit | Incentive is the market-derived anticipated reward for coordination, expertise and development risk. Profit is the reward realized after development, measured against the defined costs. | Neither is automatically a standard percentage. Identify what an estimate already includes; contractor profit and the developer's reward are not automatically the same item. |
| Economic curability and physical possibility | A condition can be physically fixable but not economically justified to fix. | Compare the supported benefit with all relevant cure costs and constraints. A renovation budget alone does not establish the value increase or guarantee an investment return. |
Work through the facts
Complete a building-only estimate
Site value is $120,000. Building-only replacement cost new is $560,000, and matching accrued building depreciation is $84,000. Separately excluded site improvements contribute $18,000 after their own depreciation.
- Building contribution: $560,000 - $84,000 = $476,000.
- Add $120,000 site and $18,000 separate contribution: $614,000.
- The $18,000 is not added if it was already included in the other figures.
Answer: The supplied property indication is $614,000.
Use a consistent age-life denominator
For this simple straight-line exercise, effective age is 12 years, total economic life is 60 years and building replacement cost new is $500,000. No separately counted losses apply.
- 12 years / 60 years = 0.20, or 20%. The numerator is years, not dollars.
- $500,000 x 0.20 = $100,000 accrued depreciation.
- $500,000 - $100,000 = $400,000 depreciated building contribution. Site value is not supplied.
Answer: Depreciation is $100,000 and building contribution is $400,000. This is not a total-property value without the site.
Remaining life is not the denominator
A stated simple age-life exercise gives effective age of 15 years and remaining economic life of 45 years. Cost new is $400,000.
- Total modeled economic life is 15 + 45 = 60 years.
- 15 / 60 = 25%; depreciation is $100,000.
- 15 / 45 would mix age with remaining life and produce the wrong fraction.
Answer: The depreciated improvement contribution is $300,000. Use the explicitly supplied model, not a rule that real buildings lose value evenly every year.
Do not add the same site improvement twice
Site value is $90,000. Cost new for all improvements, including fencing and paving, is $450,000. Total matching depreciation is $80,000. A separate note says the fence's $10,000 contribution is already within those figures.
- Depreciated improvements: $450,000 - $80,000 = $370,000.
- Add site once: $90,000 + $370,000 = $460,000.
- Adding the fence again would produce an unsupported $470,000.
Answer: The supplied indication is $460,000, not $470,000.
A repair can be economically sensible
The simplified facts supply worn flooring, a complete cure cost of $14,000 and a supported $22,000 increase in value after the repair. No other costs or constraints are assumed.
- The defect is physical and within the property.
- The stated benefit exceeds the complete cure cost by $8,000.
- That supports economic curability on these assumptions; it does not promise a real renovation profit.
Answer: The supplied facts support curable physical deterioration. A cost alone, without the benefit evidence, would not establish that conclusion.
A modern replacement already omits the obsolete feature
A modern-equivalent replacement estimate excludes an unnecessary second staircase in an old house. An analyst then deducts the full cost of reproducing that staircase as an additional loss.
- The cost basis already omits that obsolete feature.
- An additional deduction needs a distinct supported remaining loss, not a second removal of the same feature.
- Other genuine functional disadvantages can still require analysis.
Answer: Do not duplicate a loss merely because both a replacement estimate and a depreciation label are available.
New construction can still suffer a loss
A newly built house has an awkward pass-through bedroom. The surrounding site also has a supported adverse traffic influence.
- The internal layout can produce functional obsolescence even though the structure is new.
- The site influence belongs in the supported site analysis; any improvement loss needs its own consistent treatment.
- The September 2026 Fannie Mae UAD cost section distinguishes improvement depreciation from site value.
Answer: Do not assume new means zero depreciation, or apply a building depreciation fraction to the site.
A useful approach still has assignment limits
A proposed house has reliable site and construction evidence. The appraiser believes cost analysis is necessary for credible results in the identified Fannie Mae assignment.
- The cited program topic requires a necessary approach to be developed and reported.
- Fannie Mae also requires cost for manufactured-home valuations and does not accept sole reliance on cost as its market-value indicator.
- Those rules are not universal permission for cost-only work in every other appraisal or an automatic ban on cost for ordinary houses.
Answer: Follow the actual assignment and program requirements, then evaluate the cost indication's reliability.
Mistakes to avoid
- New construction has no depreciation. New improvements can still have functional or external losses.
- More detailed arithmetic proves the value. Input quality and consistent definitions still determine reliability.
- Add every listed site item. First check whether the item is already included.
- Replacement already omitted the feature, so deduct it again. Identify a distinct supported remaining loss before any additional deduction.
Check your understanding
These are original teaching questions, not recalled or predicted PSI questions. Answer first, then explain why the other choices fail.
1. Which is the basic cost-approach structure?
- Gross rent / debt service
- Sale price - mortgage balance
- Original invoice + original loan
- Site value + current improvement cost new - accrued improvement depreciation
Show answer and explanation
Answer: D. Site value + current improvement cost new - accrued improvement depreciation
The approach combines separately supported site value and depreciated current improvement cost. Seller equity, financing and an old invoice are different concepts. Separate site improvements need consistent treatment, not automatic extra addition.
2. What is replacement cost?
- Current cost of a modern improvement with equivalent utility
- The owner's original invoice
- A mandatory exact copy of every obsolete feature
- The site's assessed allocation
Show answer and explanation
Answer: A. Current cost of a modern improvement with equivalent utility
Replacement concerns current equivalent utility. Reproduction is the replica basis. An old invoice or assessed site allocation is not the definition of replacement cost.
3. Effective age is 15 years and total economic life is 75 years in a simple age-life exercise. What is the depreciation fraction?
- 60%
- 15%
- 20%
- 80%
Show answer and explanation
Answer: C. 20%
15 / 75 = 0.20, or 20%. The remaining 80% is the modeled undepreciated fraction. Calendar years alone are not a percentage, and subtracting years does not calculate this fraction.
4. In a stated simple age-life model, effective age is 10 years and remaining economic life is 40 years. What is the depreciation fraction?
- 10%
- 40%
- 25%
- 20%
Show answer and explanation
Answer: D. 20%
Total modeled economic life is 10 + 40 = 50 years, so 10 / 50 = 20%. Dividing by remaining life produces 25%, a different and incorrect denominator for this model.
5. Site value is $80,000; all-improvement cost new is $300,000 and includes all site improvements; total matching depreciation is $60,000. No other items apply. What is the indication?
- $380,000
- $440,000
- $320,000
- $240,000
Show answer and explanation
Answer: C. $320,000
$80,000 + $300,000 - $60,000 = $320,000. Do not omit the site, add depreciation or add a component already included in all-improvement cost.
6. A 30-year-old building has been renovated and is stated to compete like a typical 15-year-old building. Which is its stated effective age?
- Its original mortgage term
- 15 years
- 30 years
- 45 years
Show answer and explanation
Answer: B. 15 years
The stated effective age is 15 years; chronological age remains 30 years. This is a supplied market comparison, not a general rule that renovations halve every building's effective age.
7. Which condition is functional obsolescence?
- A mortgage payment
- A new highway's outside influence
- An awkward pass-through-bedroom layout reducing utility
- Worn roof covering
Show answer and explanation
Answer: C. An awkward pass-through-bedroom layout reducing utility
The layout is an internal utility problem. Roof wear is physical; the highway is external; debt service is financing, not a category of accrued improvement depreciation.
8. Which statement about the site is accurate?
- It always receives the building's age-life percentage
- Its historical price always determines current value
- It cannot lose market value
- Value it separately and reflect supported site influences rather than depreciating it as a building
Show answer and explanation
Answer: D. Value it separately and reflect supported site influences rather than depreciating it as a building
The site has a separately supported indication. Land can lose value, but the improvement age-life deduction is not automatically a land deduction. Historical price is evidence to analyze, not a universal answer.
9. A modern replacement estimate already removes an obsolete component. What is the danger in deducting its entire reproduction cost again?
- A mandatory profit allowance
- Duplicate recognition of the same loss
- A required tax deduction
- Automatic correction of the site value
Show answer and explanation
Answer: B. Duplicate recognition of the same loss
The estimate may already account for that obsolete feature. A further deduction needs evidence of a distinct remaining loss. It is not automatically a tax deduction, site adjustment or profit allowance.
10. A complete repair costs $20,000 and, on the simplified stated facts, adds $12,000 of value with no other benefits. Which conclusion is supported?
- The property must be demolished
- Every physical repair is economically curable
- The $8,000 difference is guaranteed profit
- The stated value benefit alone does not justify the cure cost
Show answer and explanation
Answer: D. The stated value benefit alone does not justify the cure cost
The supplied benefit is $8,000 below cost. Physical feasibility alone does not prove economic curability. The facts do not supply a demolition decision, additional benefits or a guaranteed return.
11. Which is entrepreneurial incentive?
- The anticipated market-derived reward for development coordination, expertise and risk
- The owner's mortgage amortization
- Always the same amount as contractor profit
- A universal state-required developer fee
Show answer and explanation
Answer: A. The anticipated market-derived reward for development coordination, expertise and risk
Incentive is anticipated compensation for the entrepreneur's contribution and risk. It is not a universal fixed percentage, automatically identical to a contractor allowance, or a debt payment. Identify any amount already included in the cost estimate.
12. Which statement accurately describes the cited Fannie Mae cost rule?
- Every appraisal must rely solely on cost
- Manufactured homes never need cost analysis
- Cost is prohibited for new houses
- Cost is required for manufactured-home valuations and when necessary for credible results; sole cost reliance as the market-value indicator is not accepted
Show answer and explanation
Answer: D. Cost is required for manufactured-home valuations and when necessary for credible results; sole cost reliance as the market-value indicator is not accepted
The rule has both an express property requirement and the necessary-approach principle. It does not prohibit cost for other properties or authorize sole reliance. Its scope is the identified program, not a universal Illinois appraisal statute.
13. Cost new is $500,000 and the stipulated simple age-life depreciation is 20%. Site value and site-improvement scope are not supplied. What is established?
- Total property value of $400,000
- A $400,000 depreciated improvement contribution, but not total property value
- A current land value of $100,000
- No amount can be calculated
Show answer and explanation
Answer: B. A $400,000 depreciated improvement contribution, but not total property value
$500,000 x 20% = $100,000 depreciation; the remaining improvement contribution is $400,000. Site value and other required scope information are missing. The $100,000 loss is not a land estimate, and the building calculation is not a completed property appraisal.
Common questions
What is the cost approach formula?
Site value plus current replacement or reproduction cost of improvements minus accrued improvement depreciation. Add a separate depreciated site-improvement contribution only if it is excluded elsewhere. A consistent scope keeps a correct formula from counting one item twice.
Why use current cost rather than the owner's invoice?
The appraisal concerns its effective date, while a historical invoice concerns an earlier transaction or construction period. Credibly updated historical data can be useful, but an old amount is not automatically current cost new or market value.
What is the difference between replacement and reproduction?
Replacement recreates equivalent utility with modern methods and design. Reproduction recreates the existing improvement as a replica. A historic building may make reproduction relevant, but age alone does not require that basis in every assignment.
How do I calculate age-life depreciation?
For an explicitly stated simple straight-line model, divide effective age by total economic life, then multiply by matching cost new. If effective age and remaining economic life are given, add them for that model's total. The method is a simplifying estimate, not proof that actual market loss occurs evenly each year. A depreciated building contribution is not the total property indication when site value or other required components are missing.
What if total economic life is not supplied?
Determine whether the exercise supplies effective age plus remaining economic life under the stated model. Do not silently use remaining life alone, physical life, chronological age or a mortgage term as the required denominator. If the needed assumption is absent, the fraction is not established.
Does land depreciate?
Land can decline in market value. This cost-approach structure values the site separately and applies accrued improvement depreciation to the improvements. The September 2026 UAD supplement says to recognize adverse site influences in site value rather than apply building depreciation to the site.
What counts as accrued depreciation?
Loss in value from physical deterioration, functional obsolescence and external obsolescence. Its measurement must fit the cost basis and avoid duplicate losses. It is not the same as mortgage amortization or statutory tax depreciation.
Are repairs always curable depreciation?
No. A repair can be physically possible but economically unjustified. Evaluate supported benefits against complete costs and constraints. Physical and functional losses can be curable or incurable; external loss is generally beyond the owner's ability to cure.
Do site improvements get added to every formula?
Only if the other inputs exclude them. Paving, fencing and similar additions can have finite lives and need depreciation analysis. Read whether the exercise supplies building-only cost, all-improvement cost, a developed-site value or separate contributions before adding anything.
When is cost analysis useful?
It can be useful for new, proposed or unusual improvements when site, current cost and depreciation evidence are reliable. An old or complex property can make these inputs harder to support. Neither a new building nor a detailed estimate guarantees that cost equals value.
Is entrepreneurial incentive the same as profit?
Incentive is the anticipated market-derived reward motivating development; entrepreneurial profit is the resulting reward measured against the defined costs. Neither automatically equals a contractor allowance or a prescribed percentage. The estimate must show which components are already included.
Does Fannie Mae require cost analysis for every house?
No. The identified topic requires it for manufactured homes and requires any approach necessary for credible results to be developed and reported. It does not accept sole cost reliance as the market-value indicator. Use the UAD 3.6 supplement when applicable; these program rules do not govern every other assignment.
Is this enough to produce an appraisal or insurance estimate?
No. These original examples teach inputs and exam calculations. A live appraisal needs the appropriate authority, scope, current evidence and standards. Insurance coverage and replacement estimates can use a different premise from market value. A short practice score is not a validated prediction of licensing-exam performance.
Keep practising
Your next practice step
Put valuation into practice
Choose the approach or value principle that fits the facts, then check your reasoning.
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Official sources and scope
The DRE reference supplies general cost and depreciation teaching, not current Illinois tax or licensing law. IAAO distinguishes anticipated entrepreneurial incentive from profit. Fannie Mae topics and the September 2026 UAD supplement supply the identified program rules, including separate site treatment. The Appraisal Foundation distinguishes current USPAP from its guidance manual. PSI supplies exam placement; the worked figures and questions are original.
- California DRE Reference Book, chapter 15, printed pages 406-412: general cost approach, depreciation and age-life teaching
- Fannie Mae B4-1.3-10: cost and income approach
- Fannie Mae UAD 3.6 supplement: September 2026 income policy
- Fannie Mae B4-1.3-11: reconciliation and explained weighting
- The Appraisal Foundation: current USPAP and separate guidance manual
- PSI June 24, 2026: national Valuation outline
- IAAO Glossary: entrepreneurial incentive and profit
- 225 ILCS 458/5-5: appraisal licensing and selected exceptions
This is exam preparation, not advice for a specific transaction. State law and the applicable facts control. Our editorial and corrections process explains how to report an issue.