Illinois real estate exam glossary
Depreciation in real estate: identify the value loss before calculating
A worn roof, an awkward floor plan and a noisy new highway can all reduce value. They do not have the same cause or the same cure. First identify the loss. Then decide whether the question asks for an appraisal estimate, a tax deduction or something else entirely.
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The short answer
In appraisal, accrued depreciation is the loss in the value of improvements from all causes as of the effective date. Its three broad causes are physical deterioration, functional obsolescence and external obsolescence. In the cost approach, subtract supported accrued depreciation from the applicable improvement cost new, then add the separately estimated land value and any consistently treated site improvements. A simple age-life estimate uses effective age divided by total economic life. Appraisal depreciation is different from federal tax cost recovery and mortgage amortization.
Reviewed for October 2026. PSI national III.B.3 places the cost approach within Valuation, a broader category allocated eight of the 100 scored national broker questions. That is not an eight-question allocation to depreciation. These are original study exercises, not recalled PSI questions, an appraisal, a tax return calculation or a validated readiness test. General valuation terminology is distinguished from particular lender rules, tax years and professional assignment requirements.
Classify the cause, test the cure, measure the loss
- Identify the context and date. Appraisal asks about market-supported value loss at an effective date. Tax depreciation concerns recovery of qualifying basis under tax rules. Mortgage amortization concerns loan repayment. Those amounts need not match.
- Classify the source. Physical deterioration concerns condition and wear; functional obsolescence concerns internal design or utility; external obsolescence concerns an adverse outside influence. A named feature or location is not enough without an actual supported value effect.
- Test economic curability. A correction must be feasible and justified by its supported benefit under the stated assumptions. Physical possibility alone is not enough. An economically incurable condition can still require safety work or compliance with law.
- Choose a method supported by the question. Simple age-life applies an effective-age ratio; breakdown estimates distinct items; market extraction uses consistent sale, land and cost information. An income-loss calculation also requires the right income basis, duration and rate.
- Keep the bases separate. Apply building depreciation to the appropriate improvement cost, not to land. A site can lose market value, and finite-lived site improvements need consistent treatment. Do not deduct an adverse site influence twice through site value and a repeated loss allowance.
- Calculate once and reconcile. Retain intermediate precision and avoid overlapping age-life, repair, functional and external deductions. Check that the cost basis, condition, effective date and market contribution refer to the same improvements. A precise percentage cannot repair weak assumptions.
| Concept | Meaning | Exam example or limit |
|---|---|---|
| Physical deterioration | Loss from condition, wear or damage | A worn roof; not automatically economically curable |
| Functional obsolescence | Loss from an internal utility or design deficiency or excess | An obsolete layout or a superadequate feature with unsupported cost |
| External obsolescence | Loss from an adverse influence outside the property | Supported off-site noise or economic oversupply; duration still matters |
| Curable item | A feasible correction whose supported benefit justifies its cost | An owner can perform the stated economical repair |
| Incurable item | No economically justified or available cure on the stated facts | Not necessarily impossible to measure or permission to ignore safety |
| Effective age | Age indicated by condition and utility | Can differ from years since construction |
| Total economic life | Full modeled period of economic contribution | The denominator in simple age-life |
| Remaining economic life | Modeled contribution period still ahead | Not automatically interchangeable with total life |
| Tax depreciation | Statutory recovery of qualifying basis | Can coexist with rising market value |
| Mortgage amortization | Scheduled repayment of loan principal | Not the building's physical deterioration |
The distinctions that matter
| Distinction | How it works | What to notice |
|---|---|---|
| Physical and functional | A worn component concerns physical condition. An inadequate or excessive design concerns utility. A component can present more than one issue, but each loss needs evidence. | A roof worn through use is physical. A floor plan requiring passage through a bedroom to reach another can present a functional issue. Do not call every older feature defective. |
| External source and permanent loss | An external cause is outside the property. Whether its effect is temporary or continuing is a separate question. The owner generally cannot cure the outside cause, although mitigation may be possible. | Construction noise ending in two years is not automatically a perpetual income loss. The end of an outside problem is not proof that the owner economically cured it. |
| Curability and repair cost | Economic curability compares feasible correction with supported benefit. Cost to cure and the full market value loss are not automatically identical. | A $9,000 repair with a supported $14,000 benefit points toward curability under the supplied simplified facts. A mandatory safety repair does not become optional because its value benefit is lower. |
| Chronological and effective age | Chronological age measures time since construction. Effective age reflects observed condition, utility and relevant modernization. | A 40-year-old building may have a supported effective age of 12. Renovation does not erase its construction date or automatically establish that particular effective age. |
| Total and remaining economic life | Simple age-life uses effective age divided by total economic life. If the consistent model supplies effective age and remaining life, add them to derive total life. | Effective age 20 plus remaining life 30 gives total life 50. The fraction is 20/50, not 20/30. This is a stated simple model, not a universal tax recovery period. |
| Replacement and reproduction cost | Replacement cost concerns equivalent utility with a current substitute; reproduction cost concerns a replica. Their treatment of an obsolete or excessive feature can differ. | If a selected replacement-cost base already omits a superadequate feature's excess cost, do not subtract that omitted cost again as a separate loss. |
| Appraisal loss and tax deductions | Appraisal depreciation measures the improvement's value loss from cost new. Federal tax depreciation recovers qualifying basis using statutory rules and limitations. | Accumulated tax deductions are not automatically the appraisal depreciation amount, and a rising sale price does not by itself disqualify otherwise allowable tax depreciation. |
Work through the facts
Age-life with land kept separate
An improvement has a stated cost new of $480,000, effective age of 15 years and total economic life of 60 years. Land value is $180,000. No other site item or separate loss is supplied.
- 15 years /60 years = 0.25, or 25% modeled depreciation.
- $480,000 times 0.25 = $120,000 accrued depreciation.
- $480,000 minus $120,000 = $360,000 improvement contribution; add $180,000 land.
Answer: The improvement indication is $360,000 and the simplified total cost-approach indication is $540,000. Do not apply the building's 25% ratio to the land.
Remaining life is not the denominator
A consistent simple age-life model gives effective age 20 years, remaining economic life 30 years and improvement cost new of $500,000.
- Total economic life = 20 + 30 = 50 years.
- 20/50 = 40% modeled accrued depreciation.
- $500,000 times 0.40 = $200,000 loss, leaving $300,000 for the improvement.
Answer: Use 40%, not the approximately 66.67% obtained by dividing 20 by the remaining 30. The model's life assumptions must be supplied and consistent.
Physical deterioration can be curable
A feasible paint correction costs $9,000. Supported market evidence in the exercise gives a $14,000 value benefit, with no other costs or constraints.
- The problem concerns material condition.
- The owner can perform the correction.
- The supported benefit exceeds the stated cost by $5,000.
Answer: The simplified facts support curable physical deterioration. The $14,000 benefit and $9,000 repair cost answer different questions; do not automatically treat either as every assignment's loss allowance.
A superadequacy needs a consistent cost base
The exercise expressly includes an extra $300,000 reproduction cost for an elaborate lobby. Its supported additional contribution is $70,000. No prior adjustment for that excess is included.
- The excess feature is an internal utility and market-acceptance issue.
- $300,000 cost minus $70,000 contribution = $230,000 unsupported excess under these assumptions.
- If another selected cost base already excludes the excess, the same $230,000 cannot be deducted again.
Answer: The stipulated unsupported excess is $230,000. High cost does not mean that the lobby has zero contribution, and this arithmetic alone does not prove that removal is economical.
Market extraction uses the same improvements
A comparable sold for $700,000. Its supported land value is $180,000 and the applicable improvement cost new is $650,000. The exercise states that site items, interests, condition and dates are treated consistently.
- $700,000 minus $180,000 = $520,000 indicated improvement contribution.
- $650,000 minus $520,000 = $130,000 indicated accrued depreciation.
- $130,000 /$650,000 = 20%.
Answer: The extracted loss is $130,000, or 20% of the stated cost new. The result is only as credible as the sale, land and cost evidence; it is not a universal rate for neighboring buildings.
A continuing external income loss
An off-site influence causes a supported continuing annual net operating income (NOI) loss of $18,000. The exercise expressly supplies a permanent level-loss model and a compatible 9% capitalization rate, with no overlapping deduction.
- The stated source is external.
- $18,000 /0.09 = $200,000.
- The permanence, NOI basis, rate and no-duplication assumptions make this simplified calculation possible.
Answer: The indicated loss under that model is $200,000. Do not use gross rent as NOI or apply this perpetuity model to a loss known to end soon.
A temporary loss gets a finite calculation
An external condition is stated to reduce NOI by $5,000 at each year-end for exactly two years. After that it has no further effect. Use the supplied 10% annual discount rate and no other costs or effects.
- Year one present value: $5,000 /1.10.
- Year two present value: $5,000 /(1.10 squared).
- Total present value = $1,050,000 /121, about $8,677.68595.
Answer: The modeled loss is $8,677.69 to the nearest cent. The undiscounted $10,000 total and a perpetual $50,000 estimate are different quantities and do not answer this stated present-value question.
Market appreciation and tax cost recovery can coexist
An owner has qualifying income-producing property and otherwise allowable depreciation deductions. The property's market value rises during the same period.
- The appraisal and tax questions use different measures.
- Tax cost recovery does not require matching current market-price decline.
- Land and qualifying improvements, basis, use and other tax requirements still need proper treatment.
Answer: The stipulated market rise does not by itself make the allowable deduction inconsistent. No taxpayer's eligibility, recovery period, annual deduction, bonus rule or tax liability is calculated here.
Mistakes to avoid
- Depreciation means the property sold for less than the owner paid. Accrued appraisal depreciation concerns improvement value compared with its applicable cost new. Historical whole-property price change is a different comparison.
- Use actual construction age in every age-life question. Use the effective age supplied or credibly supported for the stated model.
- Divide effective age by remaining life. The simple age-life denominator is total economic life. Derive it from effective plus remaining life only when the model supports that relationship.
- Every physical problem is curable and every functional problem is incurable. Test feasibility and supported economics for each item; the category alone does not decide curability.
- An external loss is always permanent or impossible to measure. Cause, duration, measurement and owner control are separate issues.
- Deduct repair costs, age-life loss and obsolete-feature cost in full every time. Reconcile overlaps and the selected cost basis. Do not count the same loss more than once.
- Land never loses value, and nothing on the site can depreciate. Land can change market value. Building age-life is not applied to land, and finite-lived site improvements require their own consistent treatment.
Check your understanding
These are original teaching questions, not recalled or predicted PSI questions. Answer first, then explain why the other choices fail.
1. What does accrued depreciation mean in appraisal?
- Loss in improvement value from all causes as of the effective date
- Only an annual federal deduction
- All scheduled mortgage principal payments
- The current sale price minus the owner's historic purchase price
Show answer and explanation
Answer: A. Loss in improvement value from all causes as of the effective date
The appraisal comparison concerns the improvements and applicable cost new, including physical, functional and external loss. It is different from tax recovery or loan repayment.
2. An otherwise suitable roof has deteriorated through wear. Which cause best fits?
- External obsolescence
- Physical deterioration
- Mortgage amortization
- A change in the land's legal description
Show answer and explanation
Answer: B. Physical deterioration
The stipulated loss concerns material condition. Its physical category does not by itself determine whether correction is economically curable.
3. A supported loss results from an obsolete internal floor plan. Which category applies?
- Mortgage amortization
- Tax basis recovery
- Only physical wear
- Functional obsolescence
Show answer and explanation
Answer: D. Functional obsolescence
The issue concerns internal design and utility. Age alone or personal dislike would not establish the supported market loss supplied here.
4. A new off-site noise source causes a supported value loss. Which category best fits?
- Mortgage amortization
- External obsolescence
- Physical roof wear
- Automatic tax depreciation
Show answer and explanation
Answer: B. External obsolescence
The source is outside the property. Duration and how to measure the effect remain separate questions.
5. Effective age is 18 years and total economic life is 60 years. What is the simple age-life fraction?
- 30%
- 70%
- 18%
- 42%
Show answer and explanation
Answer: A. 30%
18/60 = 0.30, or 30%. Both inputs are years; no dollar sign belongs before the age.
6. A consistent simple model gives effective age 20 and remaining economic life 30 years. What fraction applies?
- 40%
- 30%
- 20%
- 66.67%
Show answer and explanation
Answer: A. 40%
Total life is 20 + 30 = 50 years, so 20/50 = 40%. Dividing by remaining life would use the wrong denominator.
7. What makes a stated correction economically curable?
- The building is old
- The defect is visible
- It is feasible and justified by the supported benefit under the stated assumptions
- The owner dislikes the feature
Show answer and explanation
Answer: C. It is feasible and justified by the supported benefit under the stated assumptions
Physical possibility or visibility does not establish economic justification. Safety and other legal requirements remain separate from this valuation classification.
8. A 40-year-old building has a supported effective age of 12 years after modernization. Which age enters a stated effective-age model?
- 12
- Always 40
- The mortgage term
- The owner's age
Show answer and explanation
Answer: A. 12
The supplied effective age reflects the model's condition and utility assessment. Chronological age remains 40; renovation does not erase the construction date.
9. Improvement cost new is $500,000 and accrued depreciation is $125,000. What is depreciated improvement value?
- $125,000
- $4,000
- $625,000
- $375,000
Show answer and explanation
Answer: D. $375,000
$500,000 minus $125,000 = $375,000. Land and any separately treated site items have not been added to that improvement-only amount.
10. Should the building's age-life ratio also reduce land value in the standard cost-approach setup?
- Yes, always
- No; land is estimated separately, with actual site influences reflected consistently
- Yes, if the land is old
- Only if the mortgage is amortizing
Show answer and explanation
Answer: B. No; land is estimated separately, with actual site influences reflected consistently
Building depreciation applies to the appropriate improvement cost. Land can fall in market value, but that is not the same building-age calculation. Do not duplicate a site influence already reflected in land value.
11. Does accumulated tax depreciation automatically equal accrued appraisal depreciation?
- Yes, if market value rises
- No; statutory basis recovery and market-supported improvement loss are different measures
- Yes, in every rental property
- Only when the owner has a mortgage
Show answer and explanation
Answer: B. No; statutory basis recovery and market-supported improvement loss are different measures
The contexts differ. Otherwise allowable tax cost recovery can coexist with market appreciation, and the proper basis and other tax requirements still matter.
12. A replacement-cost base already omits an obsolete feature's excess cost. What should the analyst avoid?
- Deducting that omitted excess again as if still included
- Reading the market evidence
- Identifying the effective date
- Estimating site value
Show answer and explanation
Answer: A. Deducting that omitted excess again as if still included
The cost base and depreciation allowances must be consistent. A separate deduction for an amount already excluded would count the same adjustment twice.
13. A sale is $700,000, land value is $180,000 and consistently defined improvement cost new is $650,000. What is the extracted accrued depreciation?
- $180,000
- $130,000
- $520,000
- $650,000
Show answer and explanation
Answer: B. $130,000
Sale less land gives $520,000 improvement contribution. Cost new less that contribution is $130,000, or 20% of the supplied $650,000 cost base.
14. An external influence is known to last only two years. What must be considered before valuing its income loss?
- Automatically treating it as permanent
- Its finite duration, income basis, timing and an appropriate rate or supported market evidence
- A rule that all temporary loss is zero
- Only the original mortgage amount
Show answer and explanation
Answer: B. Its finite duration, income basis, timing and an appropriate rate or supported market evidence
A finite effect is not automatically a perpetuity or zero loss. The supplied cash-flow model and evidence determine the appropriate analysis.
15. An external condition reduces NOI by $5,000 at each year-end for exactly two years, then ends. Using the supplied 10% annual discount rate, what is the stated loss's present value to the nearest cent?
- $50,000.00
- $8,677.69
- $5,000.00
- $10,000.00
Show answer and explanation
Answer: B. $8,677.69
$5,000/1.10 + $5,000/(1.10 squared) = $1,050,000/121, about $8,677.68595, rounded to $8,677.69. The supplied finite annual cash flows are not a $50,000 perpetuity or an undiscounted $10,000 present value.
Common questions
What are the three types of real estate depreciation?
In appraisal, the three broad causes are physical deterioration, functional obsolescence and external obsolescence. They concern condition, internal utility and outside influence, respectively. Identify a supported value loss rather than assuming that every older feature, unusual design or nearby use necessarily causes one.
What is the simple age-life depreciation formula?
Divide effective age by total economic life, then multiply that fraction by the applicable improvement cost new. For effective age 15 and total life 60, the fraction is 25%. On a $480,000 cost base, that gives $120,000 loss and $360,000 depreciated improvement contribution. The stated simplified model is not a tax schedule or a substitute for market evidence.
What if the question gives remaining economic life?
Use the model consistently. If effective age and remaining economic life are supplied as complementary parts of the same simple life model, add them to find total economic life. Effective age 20 plus remaining life 30 gives total life 50, so depreciation is 20/50, or 40%. Do not use 20/30 or assume that an IRS recovery period is the building's economic life.
How is effective age different from actual age?
Actual or chronological age is time since construction. Effective age reflects condition and utility, including maintenance, modernization and market response. A renovation can support a lower effective age, but it does not automatically establish a fixed number or change the construction date. Use the effective age supplied or credibly supported for the assignment.
What makes depreciation curable?
The correction must be feasible and economically justified by supported benefit under the stated assumptions. A physically removable feature is not automatically economical to remove. Physical and functional items can be curable or incurable. An economically incurable classification does not authorize an owner to ignore safety, maintenance or legal obligations.
Is external obsolescence always incurable and permanent?
An owner generally cannot cure an off-site cause, though mitigation may be possible. That is different from how long the influence lasts. Temporary construction noise can end without an owner removing the cause; a continuing adverse use can last much longer. Both the amount and duration need evidence, and a finite loss should not automatically be capitalized as a perpetuity.
Does land depreciate?
In the standard appraisal cost approach, land value is estimated separately and does not receive the building's age-life deduction. Land can still rise or fall in market value because of demand, access, legal use or other influences. IRS guidance also excludes land itself from depreciation cost recovery. Certain finite-lived improvements or closely associated preparation costs can have separate treatment; do not treat every item on a site as land.
Is appraisal depreciation the same as tax depreciation?
No. Appraisal depreciation estimates the improvement's value loss from all causes at an effective date. Federal tax depreciation recovers qualifying cost or other basis under tax rules. It can coexist with rising market value. This glossary does not determine a taxpayer's eligibility, recovery period, convention, bonus deduction, recapture or tax liability, or turn the displayed 2025 publication label into a complete 2026 tax-law analysis.
Is mortgage amortization a kind of building depreciation?
No. Mortgage amortization refers to paying down principal through scheduled payments. Appraisal depreciation concerns improvement value loss. The loan balance does not measure roof wear, layout problems or outside influence. Identify the context before choosing a formula; not every mortgage has the same repayment structure.
How does market extraction estimate depreciation?
In a consistent simplified model, subtract supported land value from a comparable's sale price to isolate the relevant improvement contribution, then subtract that contribution from its applicable cost new. Site items, interests, dates and condition must match. In the stated example, $700,000 less $180,000 gives $520,000 contribution; $650,000 less $520,000 gives $130,000 loss. Weak land or cost evidence can make the apparent precision misleading.
Can a valuable luxury feature still be a superadequacy?
Yes. A feature can contribute some value while costing more than the market recognizes. Under the example's explicit incremental-cost assumptions, $300,000 cost and $70,000 contribution leave $230,000 unsupported excess. That is not a claim that all luxury features are worthless or that cost always equals a property-wide value effect. Check the selected cost base and avoid deducting an excess it already omits.
Why is double counting a problem?
A composite age-life estimate, a separate repair deduction, an obsolete-feature adjustment and an outside-influence allowance can overlap. Site value may already reflect the same adverse influence. Reconcile the bases and evidence so each effect is counted consistently once. The breakdown method can improve detail, but more lines do not guarantee a more accurate result.
Is cost to cure always the depreciation amount?
No. Repair expense, supported benefit, total market loss and an appropriate allowance can differ. The cost-to-cure information helps test feasibility and choose a supported treatment. Do not assume that the cheapest visible repair equals every consequence of a condition or that one repair estimate fixes the value impact without evidence.
Does a high depreciation percentage prove that a property is a poor purchase?
No automatic purchase conclusion follows. The estimate depends on the improvements, cost basis, effective date, evidence and method. Land value, income, price, risk and the buyer's purpose require separate analysis. This study page teaches classification and stated arithmetic, not an investment recommendation or professional appraisal.
Can I capitalize every annual loss by dividing it by a rate?
No. The income basis, duration, timing and rate must fit the method. In the finite two-year example, discount each $5,000 year-end loss at the supplied 10% rate, producing $8,677.69 total present value. Dividing $5,000 by 10% would instead model a level perpetuity and would contradict the stated two-year end. Actual assignments also need market support and consistent treatment of other effects.
Keep practising
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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 valuation references support general terminology and the stated teaching models. Fannie Mae's June 4, 2025 topic appears within its guide published October 7, 2026; its lender requirements are not universal Illinois exam formulas. The current IRS page displays Publication 946 (2025), used here for the cost-recovery distinction and qualified land treatment. No complete tax schedule, paid standards text or all-program appraisal audit is claimed. The examples stipulate their costs, contribution, lives, rates and duration.
- PSI Illinois booklet, June 24, 2026: National III.B.3 cost approach within the 8% Valuation area
- California DRE Reference Book, chapter 15, printed pages 406-412: general cost approach, depreciation and age-life teaching
- HUD Section 232 Handbook, section II, chapter 5, section 5.3.N: three causes and remaining economic life
- IAAO Glossary: functional loss, superadequacy, curability and present value
- Fannie Mae B4-1.3-10: cost and income approach
- California DRE reference chapter 15: effective-age and remaining-life examples
- Fannie Mae UAD 3.6 supplement: improvement depreciation and site value
- IRS Publication 946: qualifying use and land
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.