Percentage of depreciation is a way of measuring how much the value of a real estate asset decreases over time due to wear and tear, obsolescence, or natural causes. It is calculated by dividing the annual depreciation amount by the original cost of the asset. The annual depreciation amount is determined by applying a fixed percentage rate to the cost of the asset over its useful life. For example, if a rental property costs $100,000 and has a useful life of 27.5 years, the annual depreciation amount is $100,000 / 27.5 = $3,636. The percentage of depreciation is then $3,636 / $100,000 = 3.636%.
Depreciation is a tax deduction that allows real estate investors to reduce their taxable income from the rental income they generate from the property. It also helps them recover the cost of improvements or maintenance they make on the property. However, depreciation does not affect the cash flow or the market value of the property. It is only an accounting method that reflects the loss of value of the asset over time. Depreciation also has tax consequences when the property is sold, as the investor may have to pay taxes on the depreciation recapture or the capital gains.
Basic Theory:
Depreciation can be categorized into various methods, and one common approach is straight-line depreciation.
The formula for straight-line depreciation is:
![\[ \text{Depreciation Expense} = \frac{(\text{Initial Cost} - \text{Salvage Value})}{\text{Useful Life}} \]](https://excelcalculations.refrigeratordiagrams.com/wp-content/ql-cache/quicklatex.com-92d2dfc384fdffdc68a69b8ec7c4dec3_l3.svg "Rendered by QuickLaTeX.com")
Where:
- Initial Cost is the original cost of the asset.
- Salvage Value is the estimated value of the asset at the end of its useful life.
- Useful Life is the anticipated time the asset will be in service.
Procedures in Excel:
- Enter Data into Excel:Set up your Excel spreadsheet with the necessary data in separate cells.
Include columns for “Initial Cost,” “Salvage Value,” “Useful Life,” and “Depreciation Expense.” - Use the Formula:In the cell next to “Depreciation Expense,” input the following formula:
=($B$2 - $C$2) / $D$2
Here, B2 is the cell for Initial Cost, C2 is for Salvage Value, and D2 is for Useful Life. Adjust cell references according to your data.
- Fill Down:Drag the formula down to cover the entire useful life period.
- Format Cells:Format the cells containing numerical values as currency or accounting format for better presentation.
Explanation:
Let’s consider a scenario:
- Initial Cost: $100,000
- Salvage Value: $10,000
- Useful Life: 10 years
![\[ \text{Depreciation Expense} = \frac{($100,000 - $10,000)}{10} = $9,000 \]](https://excelcalculations.refrigeratordiagrams.com/wp-content/ql-cache/quicklatex.com-cc6d45ed7cda324fa00192994fe303d5_l3.svg "Rendered by QuickLaTeX.com")
Now, let’s create an Excel table and perform the calculations:
| Initial Cost | Salvage Value | Useful Life | Depreciation Expense |
|---|---|---|---|
| $100,000 | $10,000 | 10 | $9,000 |
| … | … | … | … |
| … | … | … | … |
| $100,000 | $10,000 | 10 | $9,000 |
Other Approaches:
- Using Excel Functions:Instead of manually entering the formula, you can use built-in Excel functions like
for straight-line depreciation.
=SLN(B2, C2, D2)
This function calculates straight-line depreciation and simplifies the process.
- Data Tables for Sensitivity Analysis:Excel’s data tables can be used to analyze how changes in initial cost, salvage value, or useful life impact depreciation.
