Depreciation is the decrease in the value of property over time due to use or wear and tear.

A modern home

What is depreciation?

Depreciation is the loss in value most property undergoes as it ages or experiences normal wear and tear. Items that depreciate have a specific time frame in which they’re considered useful. When these items are new, they have 100% of their value, but they depreciate to 0% of their value once they have reached the end of their useful age.

How does depreciation affect your home insurance?

When you buy home insurance, you need to decide if you want to insure your property for its replacement cost value (RCV) or its actual cash value (ACV). Choosing a replacement cost policy means your insurance provider reimburses you the amount it would cost to replace your damaged items with new, similar items. An actual cash value policy only pays the depreciated value.

How do insurers calculate depreciation?

Methods for calculating depreciation can vary by insurance provider. Most consider an item’s replacement cost value and its life expectancy, or how long the owner should expect to get use out of the property. Each year that passes, the item loses a percentage of its value.

Here’s an example that may make this clearer: Let’s say you buy a laptop that has a life expectancy of five years for $1,000. That means every year, the laptop loses 20% of its value. If it’s stolen after only a year, your laptop’s depreciated value is $800.

Remember, certain items don’t depreciate, like fine art, jewelry, and antiques. Some, like cars and computers, depreciate faster than others. Still others, like homes, usually appreciate instead of depreciate.

Depreciation and claims

Depreciation is also important to understand when it’s time to file a claim because it may tell you how much you get in your payout.

Let’s assume you insured that laptop for its actual cash value. When you file a claim after it’s stolen, your claim payout is $800, minus your deductible.

Even if your home insurance is written on a replacement cost basis, under most policies you initially receive the actual cash value of the damaged item. To get the rest of the payout, you typically need to:

  • Pay to repair or replace the item.

  • Submit invoices, signed contracts, receipts, or canceled checks to your insurer.

  • Complete any paperwork required by your insurer.

Keep in mind your insurance company usually pays the difference between the actual cash value and what it cost you to replace the item, subject to your deductible. For example, let’s say you spend $900 to replace the stolen laptop. Your insurer has already covered the actual cash value of $800, so the recoverable depreciation is the remaining $100.

What is recoverable depreciation?

Recoverable depreciation is the portion of your property’s depreciation that you may be able to recoup after you replace or repair covered damaged property. It’s the difference between the insured value of your property (or replacement cost) and its depreciated value.

This can apply to other assets as well, and in settings outside of insurance. For example, if you buy an asset and depreciate it for tax benefits, you may be able to sell that asset for more than its depreciated value. In this case, the difference between the depreciated (or “book”) value of the asset and the amount you sell it for (i.e., its market value) is depreciation that is said to be recovered or recaptured.

In fact, there are only really two times when depreciation is significant: when filing taxes or when insuring a home or other item. And because home prices in the US tend to rise, depreciation and depreciation recovery are rare concerns.

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