Here is one of the oldest fights in accounting, hiding inside an unassuming standard. IAS 40 is short, but it forces every company that holds property to take sides in a debate that started long before the standard existed.

IAS 40 went through the most listed real estate companies in Europe in the years after IFRS adoption, and the choice it forces matters: reported earnings, balance sheet values and the cost of capital all hang on a single policy decision. This guide walks the whole standard, from definition to disclosure, and ends with a worked example you can actually follow.

The accountant’s dilemma

How should a company value its assets? Buy a building for $1 million and the price is a fact. Ten years later, is the building still worth $1 million? The market might say $3 million. That single question splits accounting into two camps.

Historical cost values an asset at its original purchase price. It is objective, verifiable and grounded in a real transaction. Fair value values an asset at its current market worth. It is timely and reflects present economic reality. This is the classic trade-off between reliability and relevance, and IAS 40 stages it perfectly: the standard lets companies choose.

What counts as investment property

IAS 40.5 defines an investment property as:

Property (land or a building, or part of a building, or both) held to earn rentals or for capital appreciation or both.

Note the “or both.” And note the key characteristic the standard repeats: investment property generates cash flows largely independently of the other assets the entity holds. That independence is what separates it from property used in day-to-day operations.

What qualifies

  • Land held for long-term capital appreciation, not short-term resale in the ordinary course of business.
  • Land held for a currently undetermined future use.
  • A building owned by the entity and leased out under operating lease(s).
  • A vacant building held to be leased out under operating lease(s).
  • Property being constructed or developed for future use as investment property.

What does not qualify

Not investment property Handled by
Owner-occupied property: used in production, supply of goods or services, or administration IAS 16 Property, Plant and Equipment
Property held for sale in the ordinary course of business (a developer building homes to sell) IAS 2 Inventories
Property leased to another entity under a finance lease IFRS 16 Leases

The gray areas

Real situations rarely sit in the clean buckets above. Three keep appearing:

  • Dual-use properties. A building with floors you occupy and floors you rent out. If the portions can be sold or leased separately, account for them separately: owner-occupied floor as IAS 16, rented floor as IAS 40. If they cannot be sold separately, the whole property is investment property only when the owner-occupied portion is insignificant. The standard does not define “insignificant.” The practical rule of thumb is under 5% of the total property.
  • Ancillary services. Services to occupants can flip the classification. Security and maintenance in an office building are insignificant, so the building stays investment property. Own and manage a hotel, with cleaning, reception and room service, and the services are significant. That makes it owner-occupied property under IAS 16, hotel or not.
  • Inter-company rentals. The treatment depends on which statements you look at. In consolidated financial statements, property leased to a parent or subsidiary is owner-occupied from the group’s perspective, so it is not investment property. In the individual statements of the lessor entity, it is.

A decision guide:

  1. What is the primary purpose of holding the property?
    • For sale in the ordinary course of business: IAS 2.
    • For production, administration or services: IAS 16.
    • For rent or capital growth: continue.
  2. Are significant ancillary services provided to occupants?
    • Yes (you operate it like a hotel): IAS 16.
    • No (basic security and maintenance): IAS 40.

How an investment property is first measured

At cost, always. Cost includes the purchase price plus directly attributable transaction costs such as legal fees and property transfer taxes.

What does not go into initial cost:

  • Start-up costs, unless necessary to bring the property to the condition management intends.
  • Operating losses before the property reaches its planned level of occupancy.
  • Abnormal amounts of wasted material, labour or other resources.

If the property is acquired in exchange for a non-monetary asset, measure it at fair value unless the exchange lacks commercial substance or fair value cannot be measured reliably.

The big choice: cost model or fair value model

After initial recognition, the company picks an accounting policy for all of its investment property: the cost model or the fair value model. The choice is applied consistently to the whole portfolio, mixed-hairdo policies are not allowed. Unlike the revaluation model under IAS 16, IAS 40 actually lets you split by class, but the models themselves stay strict.

Path 1: the cost model

Measured at cost less accumulated depreciation and accumulated impairment, following the rules in IAS 16. Two consequences:

  • The carrying amount falls each year through depreciation.
  • Market value changes, up or down, never touch the balance sheet.

The kicker: even under the cost model, the company must still determine and disclose the fair value of the property in the notes. You cannot hide the number, you only keep it off the balance sheet.

Path 2: the fair value model

Fundamentally different, with two consequences:

  • The property is re-measured to fair value at each reporting date. Fair value, per IFRS 13, is the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date.
  • Every change in fair value goes straight to profit or loss for the period. Up by $50,000, profit rises $50,000. Down by $50,000, it falls.

No depreciation is charged. That is the logic working as intended: the asset already sits at market value each year, so charging depreciation on top would double-count the same decline.

IAS 40 carries a rebuttable presumption that fair value can be measured reliably on a continuing basis. The standard wants you on this model. Only in exceptional cases, typically an inactive market with no reliable alternative estimates, can you conclude fair value is unreliable and fall back on cost.

Cost model vs fair value model, at a glance

Feature Cost model Fair value model
Balance sheet value Cost less accumulated depreciation and impairment Fair value at each reporting date
Depreciation Charged annually Not charged
Market value changes Not recognised on the balance sheet (fair value disclosed in notes) Gains and losses to profit or loss
Primary benefit Reliability and objectivity Relevance to current market conditions
Key drawback Value goes stale as markets move Earnings volatility, relies on estimates

Fair value model vs revaluation model

Learners mix these up constantly. Both involve revaluing to fair value. The accounting is entirely different.

Feature Fair value model (IAS 40) Revaluation model (IAS 16)
Applies to Investment property Property, plant and equipment
Valuation frequency Each reporting date Periodically, when fair value differs materially from carrying amount
Gains and losses Profit or loss Other comprehensive income (OCI), held in a revaluation surplus
Depreciation Not charged Continues on the revalued amount

Two assets, same market value movement, two completely different places in the P&L versus OCI. This row alone is worth memorising for SBR.

Transfers to and from investment property

A transfer only happens on a change in use. A change in management’s intentions on its own is not evidence. You need one of these:

  • Commencement of owner-occupation: investment property to owner-occupied property.
  • End of owner-occupation: owner-occupied property to investment property.
  • Commencement of development for sale: investment property to inventories.
  • Inception of an operating lease to another party: inventories to investment property.

The accounting under the fair value model:

  • Property leaving investment property (to owner-occupied or inventories): the fair value at the date of the change becomes the deemed cost for future accounting.
  • Owner-occupied property becoming investment property: apply IAS 16 up to the transfer date. Any difference between carrying amount and fair value on that date is treated as a revaluation under IAS 16, so gains sit in OCI.
  • Inventories becoming investment property: the difference between fair value and previous carrying amount goes to profit or loss.

Under the cost model, transfers simply carry the amount over unchanged.

Disposals

An investment property is derecognised on disposal, or when it is permanently withdrawn from use with no future economic benefits expected. Gain or loss is net disposal proceeds less carrying amount, recognised in profit or loss for the period. Compensation from a third party for property that was impaired, lost or given up is recognised in profit or loss when it becomes receivable.

Disclosures

IAS 40 requires disclosures that let users evaluate the financial effects of the property held under either model:

  • Whether fair value or cost is applied.
  • If classification is difficult, the criteria used to separate investment property from owner-occupied property and property held for sale.
  • The extent to which fair value rests on a valuation by an independent qualified valuer.
  • Rental income, and direct operating expenses, split between property that generated income and property that did not.
  • Restrictions on the realisability of the property, and contractual obligations to purchase, construct or develop investment property.

Fair value model companies add a reconciliation of carrying amounts (additions, disposals, net gains or losses from fair value adjustments, transfers) and details where fair value could not be measured reliably.

Cost model companies disclose the depreciation methods and useful lives, a reconciliation of carrying amounts, and the fair value. That last one again: the number is compulsory either way.

The standard in context

The original IAS 40 came from the International Accounting Standards Committee in April 2000, and the IASB adopted it in April 2001. A revised IAS 40 followed in December 2003. The timeline since:

  • May 2008: scope expanded to property under construction or development for future use as investment property.
  • May 2011: IFRS 13 redrew the definition of fair value.
  • December 2013: clarified the relationship between IFRS 3 business combinations and IAS 40.
  • January 2016: IFRS 16 brought right-of-use assets held as investment property into scope.
  • December 2016: the transfer amendments clarified when a change in use moves property into or out of investment property.

IAS 40 superseded parts of IAS 25 Accounting for Investments (1986). Its close relatives: IAS 16 for owner-occupied property, IFRS 16 for right-of-use investment property, IFRS 13 for fair value, IAS 2 for property held for sale, IFRS 5 for investment property held for sale, IAS 36 for impairment, and IFRS 3 where acquiring property might actually be acquiring a business.

The revised standard applies to annual periods beginning on or after 1 January 2005, with earlier application encouraged. On first adopting the fair value model, the effect of classifying eligible operating-lease property interests as investment property adjusts the opening balance of retained earnings.

The overview video I built this guide alongside:

A worked example: the calculator, done by hand

I originally built this guide as an interactive tool with a live calculator. It does not run in a static blog page, so here is the same math done by hand. Take a property with:

  • Initial cost: $500,000
  • Useful life: 40 years
  • Fair value at the reporting date: $550,000

Fair value model:

  • Ending carrying amount: $550,000 (the fair value itself).
  • Gain to profit or loss: $550,000 - $500,000 = $50,000.
  • Depreciation: none.

Cost model:

  • Annual depreciation: $500,000 / 40 = $12,500.
  • Ending carrying amount: $500,000 - $12,500 = $487,500.
  • Fair value disclosed in the notes: $550,000.
  Fair value model Cost model
Carrying amount $550,000 $487,500
P&L impact +$50,000 gain $12,500 depreciation expense
Depreciation None $12,500 a year
Fair value On the balance sheet Disclosed in the notes

Same property, same year, $62,500 apart in reported profit. That gap is the whole dilemma in numbers. And the audio version if you prefer listening while working:

Key takeaways

  • Investment property is held to earn rentals, for capital appreciation, or both, and generates cash flows independently of other assets.
  • Initial measurement is at cost including transaction costs. Start-up costs, pre-occupancy losses and abnormal waste are excluded.
  • After recognition you choose the cost model or the fair value model, applied consistently across the portfolio.
  • Fair value model: no depreciation, and all changes in value hit profit or loss. Cost model: depreciation, with fair value disclosed anyway.
  • The IAS 40 fair value model and the IAS 16 revaluation model both revalue to market, but gains go to P&L under IAS 40 and to OCI under IAS 16.
  • Transfers happen only on a demonstrable change in use, and under the fair value model they are a revaluation event.

If you are wondering which model real firms actually choose, and why, the evidence is far from uniform: see IAS 40: What Actually Drives the Fair Value vs Cost Choice, where I worked through the data from 212 European real estate firms.

What is an investment property under IAS 40?

Property held to earn rentals or for capital appreciation, or both, where the cash flows are largely independent of the entity’s other assets. Owner-occupied property, property held for sale and finance-leased property are specifically excluded.

What is the difference between the cost model and the fair value model?

The cost model carries investment property at cost less accumulated depreciation and impairment, with fair value disclosed in the notes. The fair value model re-measures to fair value each period and puts all changes in value through profit or loss.

What is the difference between the fair value model and the revaluation model?

Fair value gains or losses under IAS 40 go to profit or loss. Revaluation increases under IAS 16 go to other comprehensive income through a revaluation surplus, and depreciation continues to be charged on the revalued amount.

Is depreciation charged on investment property under the fair value model?

No. The property is already stated at market value at each reporting date, so depreciation would double-count value changes.

When can investment property be transferred to another classification?

Only when there is evidence of a change in use: commencement or end of owner-occupation, commencement of development for sale, or inception of an operating lease to another party. Management’s intention alone is not evidence.

Do companies using the cost model have to disclose fair value?

Yes. Even under the cost model, IAS 40 requires the fair value of investment property to be disclosed in the notes to the financial statements.

In closing

IAS 40 is a small standard with an outsized job: it codifies an accounting debate that will not settle. Reliability and relevance pull in opposite directions, and the standard refuses to pick a winner, which is exactly what makes it such a clear lens on how accounting choices are made.

This is the pillar post for IAS 40 on this site. The research on which model firms actually choose, country by country, is the one linked above. Both were born from the same material, and I will link further thoughts here as they land.