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Posted by R. C. White on January 2, 2007, 4:36 pm
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Hi, Don.
You recognize, of course, that you are mixing apples and oranges, don't you?
The COST of a property and the VALUE of that property are two quite
different things that don't mix with each other any better than apples mix
with oranges - or bananas.
Accounting principles are based on cost. Values are a matter of opinion,
which can vary from person to person and from moment to moment. Quicken
will happily let you mix them, but just because you can does not mean that
you should. But a workable compromise can be achieved.
My recommendation is to keep your accounting on the cost basis. Your
property account should always reflect your dollars-and-cents cost of
acquiring the property and bringing it to its present condition. This cost
may or may not equal or even approximate the current market value of the
property.
Many of us also want to record and keep track of the current value of our
home and investments. One way to do this is to use a separate "valuation"
account. If our home cost us $50,000 but is now worth $150,000, we might
create an asset account with a name like "Home - Valuation Adjustment" and
start it with a value of $100,000. At any time, we can see both the cost
and market value with simple arithmetic. If the home appreciates another
$10,000 next year, we don't touch the asset cost account, but we add to the
valuation account.
One problem with this is Quicken's lack of Capital Accounts, which leaves us
nowhere to put a credit to offset the debit to the valuation adjustment
account. As any Accounting 101 student quickly learns, the basic formula
for accounting is Assets = Liabilities + Capital. Or, as Quicken says:
Assets - Liabilities = Net Worth. In other words, whatever we have, minus
what we owe is what is ours. But Quicken provides no Accounts to hold the
Net Worth, either in total or showing its multiple components (such as what
we've earned, what we were given or inherited, what resulted from
appreciation of our assets).
Lacking capital accounts, you can credit the recorded appreciation to a
Category called something like Unrealized Gain. In Quicken's system,
Accounts show up in the Net Worth reports, Categories in the Spending (or
Income and Expense) reports. Thus, both the Home and the Valuation
Adjustments accounts will be in your Net Worth, and the Unrealized Gain
category will be in your income report. Of course, the unrealized gain does
not belong in your income tax reports.
As to some of your specific concerns...
> in the Register I entered only those expenses
> incurred in 2006 for the contractor and materials that went toward
> permanent improvement of the house.
Good.
> I excluded such things as
> architectural fees and other expenses that do not directly add value to
> the house.
These fees - and maybe some of the other items - do add to your cost of the
improved home and they should be included in your basis when you compute
your gain on eventual sale. Generally, "costs" are amounts spent to acquire
or improve property; "expenses" are for amounts spent to maintain its
present condition or to repair damage, including "wear and tear". It is
very hard sometimes to draw the line between improvements and repairs, but
the distinction is usually important.
In any home improvement project, there often are items that you already paid
for that are now removed and disposed of. Your cost of these removed items
should be subtracted from your prior basis. This is usually easier said
than done! When a roof is replaced, for example, we should estimate how
much of our original purchase price for the home was for the original roof.
Even though it is difficult, the theory is clear that we should subtract the
cost of the old and add the cost of the new - unless the old roof was in bad
shape and the cost of the new one is more a repair than an improvement.
Adding a swimming pool where there was none before is more obvious - unless
we had to remove the tennis court to put in the pool.
> I realize that spending $60k on a pool and landscaping will
> not immediately, if ever, add that amount to the overall value of the
> house.
The COST of adding the pool is apples. The increase in VALUE (if any) is
oranges.
Go ahead and record the cost of the apples, even if you don't record the
value of the oranges.
> After this is all complete, this summer, I plan to have the house
> reappraised for insurance purposes and just to see what it is
> considered to be worth.
Excellent! That gives you a good amount to use for your valuation
adjustment account. After your costs of improvements and additions have
been recorded, and your cost of any dispositions deducted, subtract the new
cost balance from the appraised value; start your new valuation account with
this difference.
Most of us can't afford a new professional appraisal each year, but the
county or other property taxing authority will do it for us (whether we like
it or not). Practices vary from place to place, and some tax appraisals are
not realistic. But if your annual appraisal is reasonable (as mine is here
in Texas), you can use that to adjust your valuation account once a year.
Remember, market value is a matter of opinion, so there's no need to be too
precise.
> Second: commercial real estate. I own a property I acquired one year
> ago as part of a 1031 exchange.
Here it is especially important to keep the apples and oranges separated.
Only costs can be deducted for tax purposes, not market values. Only your
cost basis, as calculated in accordance with Section 1031 and other code
sections, can be used as the basis for your depreciation deductions. Market
values are important, of course, in setting rental rates, in financing the
property, and in the eventual sale, but those values don't belong in your
books for accounting or tax purposes.
Quicken was designed as a simple checkbook application. Many other
functions have been added to it over the years, some successfully, some more
like the tail pinned on the donkey at a kid's birthday party. Quicken does
a good job of keeping track of costs, not so well at tracking values.
RC
--
R. C. White, CPA
San Marcos, TX
(Retired. No longer licensed to practice public accounting.)
rc@grandecom.net
Microsoft Windows MVP
(Currently running Vista Ultimate x64)
>
> While toting up my end of year accounts I was wondering how to estimate
> the value of two real estate holdings.
>
> First: My house, which is in the midst of extensive improvements, which
> will cost, let's say 250k before it is over. The property is under
> Property and Debts, and in the Register I entered only those expenses
> incurred in 2006 for the contractor and materials that went toward
> permanent improvement of the house. I excluded such things as
> architectural fees and other expenses that do not directly add value to
> the house. I realize that spending $60k on a pool and landscaping will
> not immediately, if ever, add that amount to the overall value of the
> house. My other additions, a den-entertainment room, laundry room,
> guest bathroom, balcony, and veranda should be reflected more directly
> in the value of the house.
> After this is all complete, this summer, I plan to have the house
> reappraised for insurance purposes and just to see what it is
> considered to be worth. Meanwhile, does my method of adding direct
> expenses
>
> Second: commercial real estate. I own a property I acquired one year
> ago as part of a 1031 exchange. I understand that commercial real
> estate values are determined by capitalization rates, and that value is
> related to the income and fluctuating cap rate. The rental income is
> set to increase by 15% in 2010, 3 years from now. To estimate the
> current value of the property, however, I thought I would plug into the
> Register some increase in value for 2006. I am thinking the dollar
> amount would be the 15% divided by 4, for each of the four years
> between my purchase date and the date of the rent increase. Does this
> make sense?
>
> These are accounting questions, but insofar as they involve problems
> about how to enter data in Quicken, I thought maybe someone on this
> forum would have some suggestions.
>
> Best wishes to you all for 2007
> --Don
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