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Methods For Valuing Personal Property
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The three primary approaches to valuation are cost, income and the sales comparison approach. These approaches are used for valuing real estate, businesses and personal property. The underlying theory does not change. The types of data and analyses are different. The most reliable approach to value depends on the valuation engagement. The quantity and quality of data available for each approach are the key determinants of which approach to value will be most reliable. The cost approach is typically based on replacement cost less depreciation for physical, functional and external. The income approach is generally related to a multiple of annual gross or net income to provide an indication of value. The sales comparison approach is best understood because of its ubiquity in understanding the value of your house and other houses in the neighborhood.
Cost Approach as a Valuation Method Actual cost (or cost adjusted for replacement cost), less ALL types of depreciation, is an appropriate valuation method. Regrettably, what has occurred is a general practice of using somewhat arbitrary physical-life depreciation schedules based on the estimated physical life of the property therefore a chair and railroad tracks both have a seven-year life. The IRS depreciation schedules are statutory for property that cannot be expensed. However, there is no basis in fact or logic to suggest that the IRS depreciation schedules are a reasonable basis for calculating value.
What Should Not be Included in Cost Appraisal district instructions for rendering personal property direct the property owner to include: 1) cost freight to deliver, 2) cost of installation and 3) any special purpose building to house the equipment. This advice is not only bad; it is dead wrong. These instructions may be appropriate for IRS purposes. However, they are entirely inappropriate for determining the market value of tangible personal property. First, you can’t move, feel or touch delivery or the cost of installation. Second, and really to the point, these items are irrelevant to market value. Market value does not assume the buyer is the current owner. That is value-in-use, and no state determines taxes based on value-in-use for tangible personal property. Market value assumes the property is exposed to the market and is sold for its value. The cost of freight and installation would have no benefit to a purchaser, unless we assume the only purchaser is one who will leave the item in place.
Types of Depreciation Types of depreciation include physical, functional and external. Physical includes wear and tear from use. Functional depreciation addresses changes in technology and what is acceptable to purchasers. External obsolescence is based on changes outside the property for real estate and not directly related to the consideration or functional worth of the property for personal property. Functional obsolescence can reduce the value of equipment by 50 or 100% depending on the type of change. Changes in market conditions can impact the value of inventory or equipment held by industries in decline. For example, imagine a deserted army base in the middle of a desert 100 miles from the nearest town and with poor quality roads between the army base and the town. Even if the buildings are in good condition and do not have function or physical depreciation, external obsolescence could be 100 percent if there are no users or demand.
External Obsolescence (aka Economic Obsolescence) External obsolescence negatively impacts the value of drilling rigs and oil field equipment during downturns in the oil industry. The price of oil fell from over $100 in mid-2014 to about $50 in early 2017. The U.S. rig count fell from around 1,600 in September 2014 to a low of 325 and has now rebounded to 688 rigs, or forty-three percent of the level from three years ago. This is not the time for a detailed discussion of the valuation of a $1.2 billion drilling rig for offshore drilling. However, we will soon see how an offshore drilling company is valued at 25% of book value based on its stock price. The only difference being the valuation approach. We do know there is limited