IAS 40 Investment Property: Fair Value, Cost Model, and Transfers

IAS 40 is the IFRS standard that tells you how to account for land or buildings held to earn rent or benefit from capital appreciation. Under IAS 40, investment property is recognized at cost when future economic benefits are probable and cost can be measured reliably, and is then carried under either the fair value model or the cost model as a matter of accounting policy.¹ The classification decision at the front end drives almost everything that follows, because IAS 40 offers a fair value option that no other property standard allows.

What Counts as Investment Property

Investment property is land or a building held for rental income, capital appreciation, or both. It must not be owner-occupied, used to produce goods or services, or held for sale in the ordinary course of business.¹ A vacant lot held for long-term price growth, an office tower leased to third-party tenants, and a residential building rented to outside occupants all qualify.

Property used for administrative offices or manufacturing sits under IAS 16 as owner-occupied property.² Real estate purchased specifically for resale in the normal course of business is inventory under IAS 2.³ A property developer building houses to sell holds inventory, not investment property. The distinction turns on purpose: passive income, operational use, or trading stock.

Investment property under construction is also inside IAS 40’s scope. A building being constructed or developed for future use as investment property is accounted for under IAS 40 from the start, not parked in IAS 16 until completion.⁴ A right-of-use asset under IFRS 16 that meets the investment property definition can be classified under IAS 40 as well. If an entity leases a building and subleases it for rental income, that right-of-use asset qualifies. An entity that applies the fair value model to its owned investment property must also apply that model to any right-of-use assets classified as investment property.

Mixed Use and Ancillary Services

When a building is partly owner-occupied and partly leased to outside tenants, the portions must be accounted for separately if they could be sold independently. The leased portion falls under IAS 40 and the occupied portion under IAS 16. If the portions cannot be sold or leased separately, the whole property qualifies as investment property only if the owner-occupied portion is insignificant.⁴

Ancillary services create a second judgment call. An owner that provides services to occupants can still classify the property as investment property, but only if those services are insignificant to the overall arrangement. Security and routine maintenance for office tenants are insignificant, so the property stays under IAS 40. Owning and running a hotel, where guest services are the core of the business, is significant, and the property is owner-occupied under IAS 16.⁴ Entities that find the line difficult must disclose the criteria they use to draw it.

Recognition and Initial Measurement

Two conditions must be met before an investment property appears on the balance sheet. Future economic benefits must be probable, and the property’s cost must be measurable reliably.¹ The reliability requirement is not a formality. It means gathering purchase contracts, settlement statements, and valuation documentation sufficient to fix an entry value. If cost cannot be determined reliably, the property is not recognized as an asset regardless of how clearly it meets the definition. The same two-part test applies to subsequent expenditure, not only the initial purchase.⁴

An investment property that passes the recognition test is initially measured at cost.¹ Cost is the purchase price plus all directly attributable expenditures needed to bring the property into working condition for its intended use. Legal fees for conveyancing and title work, property transfer taxes, and professional services such as surveyor or engineering reports all get capitalized.

Some costs are specifically excluded from the initial measurement:

Start-up costs, including marketing for a new leasing office and pre-opening advertising, are expensed as incurred.
Operating losses incurred while the property is filling up to its planned occupancy level go to profit or loss.
Abnormal amounts of wasted material, labor, or other resources during construction or renovation are expensed rather than added to the asset’s cost.

Subsequent Expenditure

Spending after initial recognition splits into two categories. Day-to-day servicing costs, including repairs, routine maintenance, labor, and consumables, are expensed as incurred and never added to the carrying amount.⁴ Replacing a broken window or repainting a hallway is a period expense.

Replacement of a significant component is different. When the recognition criteria are met, the replacement cost is capitalized into the carrying amount and the carrying amount of the replaced component is derecognized.⁴ Swapping an elevator system or replacing an entire roof are expenditures that get added to the asset, while the old component’s remaining value comes off the books.

Fair Value Model or Cost Model

After initial recognition, the entity chooses either the fair value model or the cost model as an accounting policy.¹ The choice generally applies to all of the entity’s investment property. You cannot pick fair value for your prime office tower and cost for underperforming retail space. A narrow exception exists for property backing liabilities that pay returns linked directly to specific asset values; those can be measured under one model while the rest of the portfolio uses the other.⁴

Fair Value Model

Under the fair value model, each investment property is remeasured to its current market price at the end of every reporting period.¹ Fair value, as defined by IFRS 13, is the price that would be received to sell the asset in an orderly transaction between market participants at the measurement date. Entities typically engage independent appraisers with relevant qualifications and local market experience, though the standard does not mandate an external valuation each period.

Gains and losses from fair value changes flow directly into profit or loss for the period in which they arise. A €200,000 uplift from a nearby development pushes income up by that amount; a market downturn hits earnings just as fast. Investment property measured at fair value is not depreciated, because the remeasurement already captures the economic reality that depreciation is meant to approximate.

Cost Model

The cost model carries the property at original cost minus accumulated depreciation and any impairment losses.¹ Depreciation is calculated over the building’s estimated useful life, with the straight-line method the most common approach. Useful life is a judgment call that depends on the property type and on how the entity expects to consume the building’s economic benefits. Land is not depreciated because it has an indefinite useful life.

Regular impairment testing is required. If a building is damaged, or if market conditions push carrying amount above recoverable amount, the asset must be written down. Even under the cost model, IAS 40 requires disclosure of the property’s fair value in the notes, so readers can still assess the true market position of the real estate.⁴

When Fair Value Cannot Be Measured Reliably

There is a rebuttable presumption that an entity can measure fair value on a continuing basis. In the exceptional cases where this proves impossible for a completed investment property, the entity falls back to the cost model under IAS 16 for owned property, or IFRS 16 for a right-of-use asset, and continues using that model until the property is disposed of. The residual value must be assumed to be zero.⁵

The rules for property under construction are more flexible. If fair value is not reliably measurable during construction, the entity measures at cost until either the fair value becomes determinable or construction is completed, whichever happens first. Once an entity has measured an item under construction at fair value, it cannot later claim the completed property’s fair value is unreliable.⁴

Deferred Tax on Fair Value Gains

Fair value gains that go through profit or loss are accounting income, but they do not necessarily create a taxable event in the same period. The mismatch between carrying amount and tax base triggers deferred tax under IAS 12. When investment property measured at fair value increases in value, the entity generally recognizes a deferred tax liability reflecting the future tax it will owe when the property is eventually sold or when the value is otherwise realized.⁶

IAS 12 contains a rebuttable presumption that the carrying amount of fair-valued investment property will be recovered through sale rather than through ongoing use. The deferred tax calculation must therefore reflect sale-based tax consequences, such as capital gains tax rates, unless the presumption is rebutted. It can be rebutted if the property is depreciable and is held within a business model aimed at consuming its economic benefits over time rather than selling.⁶

Transfers Between Categories

Property can be reclassified into or out of investment property, but only when there is evidence of an actual change in use. A stated intention is not enough; the entity must show the use has genuinely shifted.⁵ The standard sets out what counts as evidence in each direction:

Investment property to owner-occupied (IAS 16): the entity begins occupying the property or starts developing it for its own use.
Investment property to inventory (IAS 2): the entity begins developing the property with a view to selling it.
Owner-occupied to investment property: the entity ends its own occupation of the building.
Inventory to investment property: the entity enters into an operating lease of the property to an outside party.

The accounting at the transfer date depends on the direction and the measurement model. When investment property carried at fair value is transferred to owner-occupied or to inventory, the property’s fair value at the transfer date becomes its deemed cost for future accounting under IAS 16 or IAS 2.¹ No gain or loss arises at the moment of reclassification.

When property moves from inventory to investment property under the fair value model, the difference between previous carrying amount and fair value at the transfer date is recognized in profit or loss, mirroring the accounting for a sale of inventory.⁷

The transfer from owner-occupied to fair-valued investment property is the most nuanced. The entity first applies IAS 16 through the transfer date, including any remaining depreciation or impairment. The difference between the IAS 16 carrying amount and fair value is then treated as an IAS 16 revaluation: a decrease generally hits profit or loss, an increase goes to other comprehensive income and the revaluation surplus in equity. If the increase reverses a prior impairment on the same property, the reversal runs through profit or loss up to the amount of the original impairment, with any remainder flowing to equity.⁴

Derecognition

An investment property comes off the balance sheet when it is disposed of or when no future economic benefits are expected from it.¹ Disposal can happen through a sale, a finance lease arrangement, or a donation. Gain or loss on disposal equals the net proceeds minus the carrying amount, with net proceeds being the sale price after directly attributable disposal costs such as broker fees and closing costs. A property carried at €500,000 and sold for €550,000 after fees produces a €50,000 gain in profit or loss. A property retired because it has been damaged beyond economic repair produces a loss equal to the entire remaining carrying amount. After derecognition, no further depreciation or fair value adjustments apply.

Disclosure Requirements

IAS 40’s disclosure requirements are extensive and differ by measurement model. Every entity must disclose which model it has chosen, the criteria it uses to distinguish investment property from owner-occupied property when the distinction is difficult, and whether fair value was determined by an independent valuer with relevant qualifications and recent local experience. If no independent valuation was obtained, that fact must be stated.⁴

Regardless of model, the entity must disclose in profit or loss:

Rental income from investment property.
Direct operating expenses (including repairs and maintenance) for properties that generated rental income during the period.
Direct operating expenses for properties that did not generate rental income during the period.

Any restrictions on the property’s realisability or on remittance of income and disposal proceeds must be disclosed, together with contractual obligations to purchase, construct, develop, repair, or enhance investment property.⁴

Entities using the fair value model must provide a reconciliation of the carrying amount from the beginning to the end of the period. The reconciliation is broken down by additions from acquisitions, additions from subsequent expenditure, acquisitions through business combinations, disposals, net gains or losses from fair value adjustments, exchange differences from translating foreign operations, and transfers to or from inventory and owner-occupied property.⁴

Entities using the cost model must disclose depreciation methods, useful lives or depreciation rates, the gross carrying amount and accumulated depreciation plus impairment at the beginning and end of the period, and a similar carrying-amount reconciliation. The cost-model reconciliation separately shows depreciation and any impairment losses recognized or reversed during the period.⁴ Cost-model entities must still disclose fair value in the notes, so the disclosure burden is significant either way.

IAS 40 Compared With US GAAP

US GAAP does not have a separate category for investment property. Real estate held for rental income or appreciation by a non-investment company is accounted for as property, plant, and equipment under ASC Topic 360, measured at historical cost with depreciation and impairment testing. The fair value option that IAS 40 offers does not exist under US GAAP for these entities.

This is the most consequential difference between the two frameworks for real estate. An IFRS reporter using the fair value model shows unrealized gains and losses flowing through its income statement as property values move, while an identical portfolio under US GAAP sits at depreciated cost until the property is actually sold. Statements prepared under the two systems can look markedly different for entities with large real estate holdings, so cross-border comparisons need to account for which framework each entity applies. Under the cost model, IFRS and US GAAP treatments are broadly consistent.

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IFRS. IAS 40 Investment Property
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IFRS Foundation. IAS 16 Property, Plant and Equipment
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IFRS Foundation. IAS 2 Inventories
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IFRS Foundation. IAS 40 Investment Property
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IFRS Foundation. IAS 40 Investment Property
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IFRS Foundation. IAS 12 Income Taxes
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IFRS Foundation. IAS 40 Investment Property