Should Real Estate Be Included on a Balance Sheet?

A balance sheet offers a financial snapshot of a company at a specific moment in time. It details what a company owns, what it owes, and the ownership stake. The fundamental accounting equation, Assets = Liabilities + Equity, forms the basis of this statement. Assets represent resources a business controls that are expected to provide future economic benefits.

The Role of Real Estate on a Balance Sheet

Real estate plays a significant role as an asset on a company’s balance sheet, representing a tangible resource. Tangible assets are items that can be seen and touched, such as machinery, vehicles, and buildings. Real estate, encompassing land and buildings, is typically categorized as a long-term asset, meaning it is not expected to be converted into cash within one year. This classification reflects its role as a long-term investment that provides future economic benefits for a business, whether through operational use or potential capital appreciation.

Businesses often acquire real estate for various purposes, including housing their operations, manufacturing facilities, or for investment. Such property is considered a fixed asset, used in the company’s operations over multiple accounting periods. The presence of real estate on the balance sheet provides insight into a company’s investment in physical infrastructure, indicating its capacity for sustained operations and long-term growth.

Initial Recording and Valuation

When a company acquires real estate, it is initially recorded on the balance sheet following the historical cost principle. This principle dictates that assets are recorded at their original cost, including the purchase price and all necessary expenditures to get the asset ready for its intended use. For real estate, additional costs beyond the initial property price might include legal fees, real estate commissions, title insurance, and any renovation or preparation expenses incurred before the property can be used for its designated purpose.

For example, if a business purchases a building, the historical cost would include the negotiated purchase price, along with any sales taxes, delivery fees for materials, or installation costs for essential systems. This approach ensures objectivity and consistency in financial reporting, as the recorded value is based on verifiable transaction data rather than fluctuating market values. Even if the market value of the real estate changes significantly over time, the balance sheet generally continues to reflect its historical cost.

Ongoing Accounting for Real Estate

After initial recording, the value of real estate on the balance sheet is adjusted through depreciation and, if necessary, impairment. Depreciation is an accounting method that allocates the cost of a tangible asset over its estimated useful life, reflecting wear, obsolescence, or consumption of economic benefits. For buildings, depreciation is typically calculated using the straight-line method, which spreads the cost evenly over the asset’s useful life.

The straight-line depreciation calculation involves subtracting any estimated salvage value (the value of the asset at the end of its useful life) from its historical cost, then dividing that amount by the asset’s useful life. For instance, the Internal Revenue Service (IRS) generally designates a useful life of 27.5 years for residential rental properties and 39 years for commercial properties. The accumulated depreciation, the total depreciation recorded for an asset since its acquisition, is presented on the balance sheet as a contra-asset account. This accumulated amount reduces the asset’s original cost to arrive at its net book value. Land is generally not depreciated because it is considered to have an unlimited useful life.

Beyond regular depreciation, real estate assets may also be subject to impairment. Impairment occurs when an asset’s carrying amount exceeds its fair value due to a permanent decline in value. This can be triggered by various events, such as significant adverse changes in market conditions, physical damage, or changes in how the asset is used. If indicators of impairment are present, a recoverability test is performed by comparing the asset’s carrying amount to its expected future cash flows. If the carrying amount exceeds these cash flows, an impairment loss is recognized, reducing the asset’s value on the balance sheet to its fair value.

Different Real Estate Classifications

Real estate is presented on a balance sheet based on its primary purpose or classification within a business. One common classification is owner-occupied property, which refers to real estate used directly in a company’s own operations, such as an office building, a retail store, or a manufacturing plant. This type of real estate is typically classified under Property, Plant, and Equipment (PP&E) on the balance sheet. It is subject to the historical cost principle and ongoing depreciation, reflecting its role in supporting the company’s core business activities.

Another classification is investment property, which is real estate held primarily for rental income or for capital appreciation, rather than for use in the company’s own operations. Under U.S. Generally Accepted Accounting Principles (GAAP), most entities are required to measure investment properties at historical cost, similar to owner-occupied property. Exceptions exist for certain entities, such as investment companies or those following specialized industry accounting practices, which may measure their real estate at fair value. When the fair value model is applied, changes in the property’s value are recognized in the income statement, and the asset is generally not depreciated.

Real estate may also be classified as held for sale if a company intends to sell the property. Once reclassified, such property is typically presented separately on the balance sheet. It is generally valued at the lower of its carrying amount or its fair value less costs to sell. This reclassification reflects a change in management’s intent and signals its impending disposition.