Real Estate Accounting: Investment Property, Capitalisable Costs, and REIT Basics

Own-Use Property vs Investment Property

The accounting treatment of real property under US GAAP is driven primarily by its intended use. Own-use property — land, buildings, and improvements used in the company's operations — is classified as property, plant and equipment (PP&E) under ASC 360. It is measured at cost less accumulated depreciation and impairment charges. Land is never depreciated; buildings and improvements are depreciated over their useful lives.

Investment property — real estate held to earn rental income, for capital appreciation, or both — follows the same ASC 360 cost model under US GAAP. This is a significant difference from IFRS (IAS 40), which allows investment property to be measured at fair value with changes through profit or loss. Under US GAAP, there is no fair value option for investment property held by non-investment-company entities, meaning balance sheet values reflect historical cost minus depreciation regardless of market value appreciation.

The practical result: a building purchased for $10 million in 2010 that is worth $30 million today still appears at its depreciated cost basis on a US GAAP balance sheet — a known limitation that makes real estate companies' book values significantly understated relative to economic reality. This is one reason why analysts use property-specific valuation metrics (NAV, FFO) rather than GAAP book values when evaluating real estate companies.

What Real Estate Costs Are Capitalised

Determining whether a real estate cost is capitalised (added to the asset's carrying value) or expensed immediately is one of the most practical and exam-tested aspects of real estate accounting. The general rule: costs that extend the useful life, increase the capacity, or add new functionality to the property are capitalised. Costs that maintain the existing condition of the property are expensed as maintenance and repairs.

For assets under construction, interest costs may be capitalised during the construction period under ASC 835-20 — but only on qualifying assets (assets requiring a substantial period of time to prepare for their intended use). Once the property is substantially complete and ready for its intended use, interest capitalisation stops. Capitalised interest is part of the asset's cost and is depreciated over the asset's useful life.

Real estate acquisition costs — purchase price, closing costs, title insurance, legal fees directly attributable to acquisition, and due diligence costs — are all capitalised as part of the property's cost basis. General and administrative costs of the acquiring company, and costs incurred after the property is placed in service, are not capitalised.

Depreciation of Real Property Under GAAP

Land is never depreciated — it has an indefinite useful life and does not wear out through use. Buildings and improvements are depreciated over their estimated useful lives using a systematic method (typically straight-line for financial reporting):

The book-tax difference in depreciation lives creates significant deferred tax liabilities for real estate-intensive companies. A 39-year MACRS recovery period vs a 40-year GAAP useful life produces a relatively modest book-tax difference, but Section 179 and bonus depreciation on non-structural components can create large deferred tax liabilities. See the tax vs book depreciation guide for a full treatment.

Impairment of Real Estate Assets

Real estate held and used is tested for impairment under ASC 360 when triggering events suggest the carrying value may not be recoverable — significant market value declines, changes in how the property is used, physical damage, or significant adverse changes in legal or business factors. The two-step ASC 360 test applies: first, compare undiscounted future cash flows to carrying value (recoverability test); if not recoverable, write down to fair value. For the complete impairment framework, see the impairment testing guide.

Real estate held for sale is reclassified to a separate line item and measured at the lower of carrying amount or fair value less costs to sell, and is no longer depreciated once classified as held for sale.

Accounting for the Sale of Real Property

When real property is sold, a gain or loss is recognised equal to net proceeds minus the carrying value (original cost minus accumulated depreciation). If installment payments are involved, the installment method may be used to defer gain recognition proportionally as payments are received, provided the criteria are met. For tax purposes, depreciation recapture rules (Section 1250 for real property) tax a portion of the gain at ordinary rates to the extent of straight-line depreciation claimed — an important distinction from GAAP, which recognises the full gain in the period of sale.

REIT Basics: Structure and Reporting

A Real Estate Investment Trust (REIT) is a company that owns, operates, or finances income-producing real estate and qualifies for special tax treatment under Subchapter M of the IRC. To qualify as a REIT, a company must: (1) invest at least 75% of total assets in real estate; (2) derive at least 75% of gross income from real estate sources (rents, mortgage interest); (3) distribute at least 90% of taxable income to shareholders as dividends annually; (4) have at least 100 shareholders; and (5) not have more than 50% of shares held by five or fewer shareholders (the "five or fewer" test).

The 90% distribution requirement is what gives REITs their distinctive character — they must pay out most of their income as dividends, which is why REIT dividends are typically higher than those of regular corporations. Because they pass through most income to shareholders, REITs pay little or no corporate income tax — the tax is paid at the shareholder level on dividends received.

Funds From Operations (FFO): The REIT Performance Metric

GAAP net income is considered a poor measure of REIT performance because it deducts depreciation on real property — a non-cash charge that reflects accounting convention rather than economic reality (real estate values often appreciate over time, not depreciate). Funds From Operations (FFO), as defined by NAREIT (National Association of Real Estate Investment Trusts), adjusts for this:

FFO per share is the dominant valuation metric for publicly traded REITs, comparable to EPS for traditional companies. Price-to-FFO multiples (analogous to P/E ratios) are the primary valuation benchmark. Investors use AFFO — which further adjusts for recurring capital expenditures — to assess the sustainability of dividend payments. A REIT paying dividends in excess of AFFO is potentially consuming its capital base.