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?

Snippet answer: 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

Snippet answer: 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cost is the cost to build an exact replica of the improvements, using the same materials and design, including outdated features.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 The cost to build an exact duplicate of the improvements, using the same materials, design, and layout, even outdated ones.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

Snippet answer: 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 it is always incurable. Land itself does not depreciate.

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 always incurable. It comes from outside the property line, like traffic noise or a factory next door, and the owner cannot fix what they do not control. Physical and functional problems can be curable or incurable, but external is always 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

Snippet answer: 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, or when the cause is outside the property. External obsolescence is always incurable.

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

Snippet answer: 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. Insurers use replacement cost to decide how much it would take to rebuild, which is the property's insurable value, not its market value.

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: your appraisal district uses the cost approach

Snippet answer: Texas county appraisal districts use a mass-appraisal version of the cost approach to value many properties for property taxes. Your notice of appraised value shows a separate land value and improvement value, which mirrors the cost approach. The district estimates the replacement cost of the improvements, subtracts depreciation, and adds the land value.

Here is where the cost approach becomes real money for every Texas owner. County appraisal districts value large numbers of properties at once, called mass appraisal, and they lean on the cost approach to do it.

Look at a Texas notice of appraised value. It lists a land value and an improvement value as separate line items, which is exactly the cost approach structure. The appraisal district estimates the replacement cost of the improvements, subtracts depreciation, and adds the land value to reach the appraised value used for your property taxes. Keep in mind this appraised value for taxes is not the same as a market value opinion, and for a homestead it can be limited by the appraisal cap.

Common exam traps to remember

Snippet answer: Cost approach questions punish a few confusions: thinking land depreciates, forgetting external obsolescence is always incurable, mixing up reproduction and replacement cost, and using the cost approach for a typical resale home.

• Land does not depreciate. Only the improvements lose value, and land is added separately.
• External obsolescence is always incurable. It comes from outside the property and cannot be cured by the 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. It comes from outside the property and is always incurable. (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, but external obsolescence is always incurable.

Which type of depreciation is always incurable?

External obsolescence, also called economic obsolescence, is always incurable. It comes from factors outside the property line, such as a nearby highway, an airport, or a declining neighborhood. The owner cannot fix what they do not control, so it cannot be cured.

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 Texas primary sources and standard appraisal principles on July 21, 2026. The cost approach formula of land value plus the cost to build the improvements new minus accrued depreciation, the distinction between reproduction cost and replacement cost, the three types of depreciation being physical deterioration, functional obsolescence, and external obsolescence, the rule that external obsolescence is always incurable, the rule that land does not depreciate, and the situations where the cost approach is most reliable, reflect settled appraisal concepts tested on the national portion of the exam. The point that Texas county appraisal districts use a mass-appraisal cost approach and that a Texas notice of appraised value shows separate land and improvement values reflects the Texas Property Tax Code, including the notice requirements of Section 25.19, and Texas Comptroller guidance on valuing property. The homestead appraisal cap that can limit a residence homestead's taxable value is detailed in the linked homestead guide. Statutes and appraisal standards can change, so verify the current Texas Tax Code and appraisal standards before relying on any point in practice.

Official Source Links

• Texas Comptroller: Valuing Property
• 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.