IAS 40 and Investment Property Explained: Should a £350,000 Rental Property Be Measured at Cost or Fair Value?

If your company owns a rental property – perhaps a flat above your showroom, a warehouse you no longer trade from, or a buy-to-let bought through the business – the way you account for it can change your reported profit, your balance sheet, and how your bank reads your accounts. A lot of SME owners assume property is property: you buy it for £350,000, keep it on the balance sheet at historical cost, and ignore market fluctuations. Under the international standard that governs rental property, IAS 40 Investment Property, you only follow a traditional cost-and-depreciation approach if you select the cost model. Choose the fair value model and the same £350,000 flat could show a £15,000 gain in your accounts one year and a £25,000 loss the next – with neither figure ever touching your bank account. This article explains, in plain English, the two ways you can account for investment property, works through a real £350,000 example, and shows what it means for your profit, your balance sheet and your corporation tax computation.

What Counts as Investment Property?

Investment property, under IAS 40 (and the similar rules in FRS 102 Section 16 for companies using UK GAAP), is land or a building you hold to earn rent, to benefit from the property increasing in value, or both – not property you use yourself to run your business, and not property you are building to sell on as stock. So the office your team works from every day is not investment property; it sits under a different standard (IAS 16, or FRS 102 Section 17) and is accounted for as owner-occupied property, plant and equipment. But a separate flat above that office which you let out to a tenant, a warehouse you have mothballed and now rent to a logistics firm, or a residential buy-to-let held through your trading company, all count as investment property. The distinction matters because investment property gets its own set of measurement rules – and under IAS 40, an accounting policy choice between cost and fair value that owner-occupied property does not get.

Cost Model or Fair Value Model: The Choice That Changes Everything

Once you have identified a property as investment property, IAS 40 gives you a choice, but it is an accounting policy choice you must apply consistently to all investment property you hold – you cannot measure one building at cost and another at fair value just because it suits your numbers that year. The cost model works the way most people instinctively expect: you record the property at what you paid for it, then depreciate the building element over its useful life and reduce it further if it becomes impaired, exactly as you would an owner-occupied building or a piece of machinery. You still have to disclose the fair value in the notes to the accounts, but that valuation movement does not hit the balance sheet carrying value or the profit and loss account. The fair value model works very differently: at every year end, you revalue the property to its current market value, and crucially, that movement goes straight through profit or loss, not into a revaluation reserve. If the value goes up, you book a gain in profit; if it goes down, you book a loss. No depreciation is charged under this model, because the property is remeasured to market value every year regardless. By contrast, UK GAAP under FRS 102 generally mandates fair value through profit or loss for investment properties (the former ‘undue cost or effort’ exemption having been removed by the Financial Reporting Council), leaving the cost model available only under FRS 105 for micro-entities or for certain intra-group property lettings.

Worked Example: A £350,000 Rental Property

Take Hartley Interiors Ltd, a small furniture retailer that owns a two-bedroom flat above its showroom. The flat is let to a tenant on an assured tenancy and generates rental income completely separate from the furniture trade, so it meets the definition of investment property. Hartley Interiors bought the flat on 1 January 2023 for £350,000 and, reporting under international standards, elected to apply the fair value model rather than the cost model because the directors wanted the balance sheet to reflect the flat’s true market value for lending purposes. At each year end, the company commissions an independent RICS valuation. Here is what happened over the following two years.

To see the difference the choice of model makes, here is how the same flat would have looked under the cost model over the same two years, assuming a fifty-year useful life for the depreciable building element and no residual value, giving annual depreciation of £7,000.

What This Means For Your Business

The accounting treatment you choose for investment property is not just a technical box-ticking exercise – it changes the profit figure your bank sees, the deferred tax provisions your accounts must show, the adjustments required on your corporation tax return, and the valuations you will need every year end. Here is what to do next.

1. Check your applicable financial framework: IAS 40 provides a genuine policy choice between cost and fair value, whereas UK GAAP under FRS 102 mandates fair value through profit or loss for standard investment properties.
2. If you use the fair value model, budget for an annual valuation (an independent RICS valuation is best practice and widely expected by lenders and auditors) and prepare for fluctuations in reported operating profit, ensuring stakeholders understand these are non-cash movements.
3. Remember that unrealised fair value gains and losses are stripped out of your current corporation tax computation, though deferred tax will generally need to be recognized in your financial statements.
4. Keep meticulous records of the property’s original acquisition costs and allowable capital enhancements, because those historical figures will be needed to calculate your chargeable gain or allowable capital loss when the property is sold.