When you hear about a property that has reached the end of its useful life when investing in real estate, you may think that it is a building that can no longer be used. However, the statutory useful life is the number of years used to calculate depreciation for tax purposes, and is not the physical lifespan of the building itself.
On the other hand, properties that have passed their legal useful life greatly affect depreciation, tax burden, bank financing, repairs, and the number of buyers when selling. Although a cash purchase may seem attractive, the financing period may be short, repair costs may be high, and exit options may be narrow.
In this article, we will explain to investors and owners what happens when a property reaches the end of its useful life.
Useful life has three meanings
The term useful life has different meanings depending on the situation.
| Type | Meaning | Situation where it is used |
|---|---|---|
| Statutory useful life | Number of years used for tax depreciation | Final tax return, accounting, taxation |
| Physical service life | Period during which a building can be physically used | Repairs and building diagnosis |
| Economic life | Period that produces value as an income property | Investment decisions, sales, financing |
Regarding depreciable assets, the National Tax Agency explains that buildings and other assets are assets whose value decreases with the passage of time, and that the statutory useful life, which corresponds to the usable period, is stipulated in the appendix of the Ministry of Finance Ordinance.
In other words, just because a building has passed its legal useful life does not mean that it cannot be used immediately. In practice, we look at the building condition, repair history, rental demand, and loan evaluation.
Statutory service life by structure
The typical legal service life of a residential building varies depending on its structure.
| Structure | Legal service life for residential buildings |
|---|---|
| Wooden/synthetic resin construction | 22 years |
| Timber frame mortar construction | 20 years |
| Steel reinforced concrete construction / reinforced concrete construction | 47 years |
| Brick/stone/block construction | 38 years |
| Metal construction | Varies depending on the thickness of the frame material |
Wooden apartments, which are commonly seen in real estate investments, have a lifespan of 22 years, and RC condominiums have a lifespan of 47 years. This difference affects the amount of depreciation, loan term, and exit price.
What happens to depreciation after the useful life?
If a building is depreciated according to its legal useful life from the time of new construction, depreciation can basically no longer be recorded at the end of its useful life. Depreciation is an expense that does not involve cash expenditures, so when it is eliminated, your taxable income increases and your tax burden may become heavier.
| Status | Tax Implications |
|---|---|
| During depreciation | A portion of the building acquisition cost is expensed every year |
| After depreciation ends | Depreciation expenses decrease, making it easier to increase taxable income |
| Large-scale repairs | Treatment differs depending on whether it is a repair cost or capital expenditure |
| At the time of sale | Acquisition costs and accumulated depreciation affect capital gains |
It is important to note here that more depreciation does not necessarily mean better value. Even if your tax burden falls while you hold the property, the book value after depreciation may be lower when you sell it, and your capital gain may increase.
Useful life of used property and simplified method
When acquiring used assets, in principle, the useful life should be estimated based on the period during which they can be used after acquisition. However, when estimation is difficult, a simplified method is accepted.
The National Tax Agency's useful life review Q&A explains that when it is difficult to estimate the useful life of used assets, a simplified method can be used depending on the number of years that have passed.
A typical idea is as follows.
| Situation | Concept of the simplified method |
|---|---|
| Entire legal useful life has elapsed | Legal useful life x 20% |
| Partially elapsed | Statutory useful life - number of elapsed years + number of elapsed years x 20% |
| Calculation results less than 2 years | 2 years |
For example, if a wooden apartment building with a legal useful life of 22 years has passed its useful life, then 22 years x 20% = 4.4 years, which is rounded to 4 years.
Impact on financing
For bank loans, the statutory useful life and remaining useful life are sometimes used as a guideline for the loan period. For properties that have far exceeded their useful life, the building's evaluation will be seen as low, resulting in a shorter loan period and a slower rate of loan growth.
| Impact | Content |
|---|---|
| Loan period | May be shortened based on remaining useful life |
| Collateral evaluation | Building evaluation becomes lower and land evaluation becomes more important |
| Own funds | Many things are required |
| Repayment amount | The shorter the period, the heavier the monthly repayments |
| Exit | Buyer may also find it difficult to obtain financing |
Areas with strong land values or properties with a good repair history may be evaluated better. However, it is important to note that the number of buyers who can obtain financing for properties that have exceeded their useful life is likely to be limited.
Impact on cash flow
The purchase price of properties that have exceeded their useful life may appear to be low. However, cash flow is not determined by price alone.
The points to check are as follows.
- Tax burden after depreciation ends
- Increase in repair costs
- Vacancy rate/rent decline
- Repayment burden due to shortened loan period
- Conditions of fire insurance/earthquake insurance
- Buyer demographic when selling
Even if the surface yield is high, if repairs and repayments overlap, the remaining balance will be thin. Especially for older wooden buildings, check the roof, exterior walls, water supply and drainage pipes, termites, foundation, and electrical capacity before purchasing.
Impact on sale/exit strategy
Even properties that have reached the end of their useful life can be sold. However, the attributes of the buyer will change. Rather than buyers using regular loans, the focus may be on cash investors, investors who place emphasis on land value, rehabilitation businesses, and buyers who plan on rebuilding the property.
| Exit | Suitable property |
|---|---|
| Sold as an income property | There is rental demand and a good repair history |
| Sell at land value | Land value is stronger than building value |
| Sold to a recycling business | There is room for renovation and the location is good |
| Sold on the assumption of rebuilding | Good floor area ratio, access, and rights |
| Long-term ownership | Stable repair plans and rental demand |
If you buy an old property without thinking about the exit plan, you will be at a disadvantage when it comes to price negotiations because you will have a limited number of potential buyers when you sell the property. Before making a purchase, it is important to think about who will buy it next.
Checklist for investment decisions
When considering a property that has exceeded its useful life, be sure to check the following items.
| Item | Check details |
|---|---|
| Building diagnosis | Leakage, tilting, termites, plumbing |
| Repair history | Roof, exterior walls, water supply and drainage, common areas |
| Rental demand | Surrounding rent, vacancy rate, tenant attributes |
| Loan conditions | Borrowing period, interest rate, own funds |
| Taxation | Depreciation period, taxation at time of sale |
| Insurance | Availability of fire/earthquake insurance |
| Exit | Land value, resale destination, room for reconstruction |
Rather than just buying based on the high yield, it is necessary to look at repairs, financing, taxes, and exit all in one.
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- Apartment investment risk analysis and mitigation measures | How to prepare for vacancies, repairs, and interest rate increases
INA&Associates' philosophy
End-of-life properties can be an investment opportunity if handled with understanding. However, if you purchase with only the tax benefits in mind, you may have trouble with repairs, financing, and exit.
We focus on the building condition, management history, tenant demand, financial planning, and sales potential rather than the age of the building itself. Is it a property that can be held for a long time, a property that can be regenerated, or a property that retains value as land? Only after looking at this point can you make a judgment about older real estate.
FAQ
Q. Can I use a building that has passed its legal useful life?
You can use it. The statutory useful life is a number of years for tax purposes and is different from the physical life of a building. Judgment will be based on building condition and repair history.
Q. Will there be tax savings on properties that have exceeded their useful life?
It may be possible to depreciate in a short period of time. However, it is necessary to take into account capital gains at the time of sale, repair costs, and financing conditions when making your decision.
Q. Can I get a bank loan?
It may be difficult to receive. It varies depending on land evaluation, profitability, tenant attributes, and financial institution policies. Please check financing terms before purchase.
Q. Are old properties difficult to sell?
The buyer base may be limited. The possibility of selling increases if there is rental demand, land value, room for revitalization, and repair history.
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