The Cost Approach and Depreciation: Texas Exam

The cost approach asks a simple question: what would it cost to build this property today, minus the wear it has picked up, plus the land? It is one of the three approaches to value, and the exam tests its formula and, above all, the three types of depreciation.

What is the cost approach?

The cost approach estimates value by adding the land value to the cost of building the improvements new, then subtracting accrued depreciation. The formula is value equals land value plus cost new minus depreciation. It assumes a buyer would not pay more for a property than the cost to buy the land and build an equal replacement.

The cost approach values a property as if you rebuilt it. You find the land value, add what it would cost to build the improvements new, and subtract the depreciation the existing building has suffered. In one line:

Value = Land Value + (Cost New of Improvements − Accrued Depreciation)

The logic is the principle of substitution again. A buyer would not pay more for a property than the cost to buy a similar lot and build an equal building on it. Note that the land is added separately, because land is valued on its own, usually by comparing recent land sales.

The steps are straightforward. Estimate the land value as if vacant. Estimate the cost to build the improvements new. Estimate the depreciation. Subtract the depreciation from the cost, then add the land value back.

Reproduction cost vs replacement cost

Reproduction cost is the cost to build an exact replica of the improvements, using the same materials and design, including outdated features. Replacement cost is the cost to build a functional equivalent using current materials and standards. Replacement cost is more common in practice, because few buyers want an exact copy of an old building.

The cost approach needs a cost figure, and there are two ways to define it.

• Reproduction cost. The cost to build an exact duplicate of the improvements, using the same materials, design, and layout, even outdated ones. It reproduces the building flaws and all.
• Replacement cost. The cost to build a functional equivalent using today's materials, methods, and standards. It replaces the building's utility, not its exact form.

Replacement cost is the one used most often, because a buyer usually wants a building of equal usefulness, not an exact copy of a dated design. Reproduction cost matters most for historic or architecturally unique buildings where the exact form has value.

The three types of depreciation

Depreciation in the cost approach is loss in value from any cause, and it comes in three types. Physical deterioration is wear and tear. Functional obsolescence is outdated design or features inside the property. External obsolescence is loss from factors outside the property and is normally treated as incurable by the subject-property owner. Land itself does not depreciate in the cost-approach calculation.

Depreciation is the most tested part of the cost approach. Here it means any loss in value of the improvements from any cause, and it splits into three types.

Two points win most of the questions.

First, external obsolescence is normally treated as incurable on exam questions. It comes from outside the property line, like traffic noise or a factory next door, so the subject-property owner normally cannot remove the cause. In real appraisal work the outside influence can be temporary or later change, so “always” is too absolute. Physical and functional problems can also be curable or incurable.

Second, land does not depreciate. Only the improvements lose value to depreciation. Land is added at its own value, which is why the formula keeps land separate. An "improvement" here means a building, structure, or fixture on the land.

Curable vs incurable depreciation

Depreciation is curable when the cost to fix it is less than or equal to the value it adds back, so fixing it makes economic sense. It is incurable when the cost to fix it is more than the value added. External obsolescence is normally classified as incurable at the property level because its cause is outside the owner's control.

Physical and functional depreciation each come in two flavors, and the test is money.

• Curable. The item is worth fixing, because the cost to cure is less than or equal to the value the repair adds. A worn but replaceable carpet or an easy kitchen update is often curable.
• Incurable. The item is not worth fixing, because the cost to cure is more than the value it would add, or the problem cannot be fixed at all. A cracked foundation may be incurable in practice, and anything caused by outside forces is incurable by nature.

The habit for the exam is to ask whether fixing the problem pays for itself. If yes, it is curable. If not, or if the cause is outside the property, it is incurable.

When the cost approach is best

The cost approach is most reliable for new construction and special-purpose properties like schools, churches, and government buildings, where there are few comparable sales and no income to measure. It is also used for insurance, to estimate the replacement cost of the improvements. It is weakest for older buildings, where depreciation is hard to estimate.

The cost approach shines in a few situations.

• New construction. A brand-new building has little depreciation, so the cost figure is close to the value.
• Special-purpose property. Schools, churches, libraries, fire stations, and government buildings rarely sell and produce no income, so sales comparison and the income approach fall short. The cost approach fills the gap.
• Insurance. Replacement-cost estimates can help measure the cost to rebuild covered improvements. They exclude land and are not the same as market value; the policy terms, limits, and covered loss still control what the insurer pays.

Its weakness is the older property. The longer a building has stood, the harder its depreciation is to measure, so the cost approach gets less reliable with age. For a typical resale home, the sales comparison approach usually leads instead.

Texas connection: appraisal districts may use the cost approach

Texas appraisal districts use mass appraisal and may apply the cost, sales-comparison, or income approach as appropriate. In a cost model, the district estimates the cost of replacing improvements, subtracts depreciation, and adds land value. Texas Tax Code Section 25.19 specifies what a notice of appraised value must contain, but it does not require every notice to show separate land and improvement line items.

Here is where the cost approach connects to Texas property tax. County appraisal districts value large numbers of properties at once, called mass appraisal. The Comptroller identifies three common approaches they may use and says the cost approach is best suited to new construction, unique property, and property with scarce sales and income data.

District records or local notices may show land and improvement components, but presentation varies. With limited exceptions, Tax Code Section 23.01 requires taxable property to be appraised at market value as of January 1, using mass-appraisal standards and consistent methods. A tax appraisal is therefore a market-value determination in that statutory system, not a private fee appraisal; a homestead cap, circuit-breaker limitation, exemption, or special appraisal can make the final appraised or taxable value differ from uncapped market value. See the property-tax guide and appraisal-cap guide for those layers.

Common exam traps to remember

Cost approach questions punish a few confusions: depreciating land in the formula, forgetting the exam treatment of external obsolescence, mixing up reproduction and replacement cost, and using the cost approach as the automatic first choice for a typical resale home.

• Land does not depreciate. Only the improvements lose value, and land is added separately.
• Exam treatment: external obsolescence is normally incurable. Its cause is outside the subject property and normally cannot be cured by that owner.
• Reproduction is an exact copy, replacement is equal utility. Replacement cost is more common in practice.
• Curable means the fix pays for itself. If the cost to cure is more than the value added, it is incurable.
• Use the cost approach for new or special-purpose property. For a normal resale home, sales comparison usually leads.

You can drill these against timed Texas questions in the free practice test, and look up any unfamiliar term in the Texas real estate glossary.

Original practice questions

Use these to check yourself. They are written for practice and are not copied from any real exam.

Question 1. A home loses value because a busy new highway was built right behind it. Which type of depreciation is this?

• A) Physical deterioration
• B) Functional obsolescence
• C) External obsolescence
• D) Curable depreciation

Answer: C. A negative factor outside the property line, like a new highway, is external obsolescence, sometimes called economic obsolescence. Exam questions normally treat it as incurable at the property level. (Original question.)

Question 2. An older home has only one bathroom and an awkward floor plan that buyers dislike. Which type of depreciation is this?

• A) Physical deterioration
• B) Functional obsolescence
• C) External obsolescence
• D) None, because the house is still usable

Answer: B. Outdated design or features inside the property, like too few bathrooms or a poor layout, are functional obsolescence. It can be curable or incurable depending on the cost to fix it. (Original question.)

Question 3. In the cost approach, which item is added separately and does not depreciate?

• A) The roof
• B) The land
• C) The kitchen
• D) The foundation

Answer: B. Land does not depreciate in the cost approach. Only the improvements lose value, and the land is valued on its own and added back after depreciation is subtracted. (Original question.)

Question 4. An appraiser must value a newly built church with no comparable sales and no rental income. Which approach fits best, and what is its formula?

• A) The income approach, net income divided by a rate
• B) The sales comparison approach, adjusting comps
• C) The cost approach, land value plus cost new minus depreciation
• D) The gross rent multiplier

Answer: C. The cost approach fits new or special-purpose property like a church. Its formula is land value plus the cost to build new, minus accrued depreciation. (Original question.)

Frequently Asked Questions

For quick answers to every common Texas exam question, see the Texas real estate exam FAQ.

What is the cost approach to value?

The cost approach estimates value by adding the land value to the cost of building the improvements new, then subtracting accrued depreciation. The formula is value equals land value plus cost new minus depreciation. It assumes a buyer would not pay more than the cost to buy the land and build an equal replacement.

What is the difference between reproduction cost and replacement cost?

Reproduction cost is the cost to build an exact replica of the improvements, with the same materials and design, including outdated features. Replacement cost is the cost to build a functional equivalent using current materials and standards. Replacement cost is more common, because buyers usually want equal utility, not an exact copy.

What are the three types of depreciation?

The three types are physical deterioration, which is wear and tear on the building; functional obsolescence, which is outdated design or features inside the property; and external obsolescence, which is loss from factors outside the property. Physical and functional can be curable or incurable. Exam questions normally treat external obsolescence as incurable at the property level.

Which type of depreciation is always incurable?

External obsolescence, also called economic obsolescence, comes from factors outside the property, such as a nearby highway, an airport, or a declining neighborhood. The subject-property owner normally cannot remove that cause, so exam questions classify it as incurable. In real appraisal work an external influence may be temporary or later disappear, which is why “always incurable” is too broad outside an exam shortcut.

Does land depreciate in the cost approach?

No. Land does not depreciate in the cost approach. Only the improvements, meaning the buildings and structures, lose value to depreciation. Land is valued on its own and added back after depreciation is subtracted from the cost of the improvements.

When is the cost approach used?

The cost approach is most reliable for new construction and special-purpose property like schools, churches, and government buildings, where there are few comparable sales and no income. It is also used for insurance, to estimate replacement cost. It is weakest for older homes, where depreciation is hard to estimate.

Sources and Methodology

This article was reviewed against current Texas primary sources and standard appraisal principles on August 12, 2026. The cost-approach formula, reproduction-versus-replacement distinction, three forms of depreciation, and best-use cases reflect appraisal concepts tested on the national exam. “External equals incurable” is identified as the normal exam treatment, not an absolute claim about every outside influence over time. Texas Tax Code Sections 23.01, 23.011, and 25.19 and current Comptroller guidance support the January 1 market-value rule, mass-appraisal framework, common valuation approaches, cost-method mechanics, and required notice contents. Those sources do not require every notice to display separate land and improvement lines. The linked tax guides explain appraisal limitations, special appraisal, exemptions, and taxable value. Statutes and appraisal standards can change, so verify the current Texas Tax Code and applicable appraisal standards before relying on a real valuation.

Official Source Links

• Texas Comptroller: Valuing Property
• Texas Tax Code Chapter 23 (Appraisal Methods and Procedures)
• Texas Tax Code Section 25.19 (Notice of Appraised Value)
• Texas Comptroller: Property Tax System Basics
• TREC: Become a Real Estate Sales Agent

This post is educational content for Texas real estate sales agent candidates. It is not appraisal or tax advice. Value opinions and property tax valuations depend on the facts and current law, so confirm the current Texas Tax Code and appraisal standards and consult a licensed professional before you rely on any point in a real situation.