Lowest-value principle

Lower-of-cost-or-market principle - The lower-of-cost-or-market principle is a valuation principle in commercial accounting (Section 253 of the German Commercial Code (HGB)) that stipulates that, in case of doubt, assets must be carried at the lower value. For real estate held as business assets, this means: If the current market value is permanently below the book value, an extraordinary write-down to the lower value must be made. The principle serves to protect creditors and ensure prudent accounting.

Application to Real Estate

Real estate is carried on the balance sheet at amortized cost-that is, the purchase price less accumulated depreciation. The lower-of-cost-or-market principle applies when the fair value (market value, income value) falls permanently below the book value.

For land classified as fixed assets, the modified lower-of-cost-or-market principle applies: Depreciation is required only in the event of a permanent impairment (§ 253 (3) HGB). A temporary market correction is not sufficient.

For land classified as current assets (e.g., for property developers and project developers), the strict lower-of-cost-or-market principle applies: Any impairment-even temporary-must be written off immediately. Property developers who have acquired real estate at high purchase prices and are now suffering from market corrections may thus be forced to take significant write-downs, which reduce equity.

Tax Parallel: Partial Value Depreciation

In tax law, the lower-of-cost-or-market principle corresponds to partial write-down (Section 6(1)(1-2) of the German Income Tax Act (EStG)). Here, too, a property in business assets may be written down to its lower partial value if there is a likely permanent impairment. The tax authorities impose strict requirements for proof-an expert opinion is generally required.

Partial write-down offers a tax advantage: The early write-down reduces taxable income, which lowers the company’s current tax burden. However, the reversal of the write-down must be recorded later if the value rises again.

Requirement to Reversal and Obligation to Write Up

The lower-of-cost-or-market principle is not a one-way street. According to Section 253(5) of the German Commercial Code (HGB), there is a requirement to reverse write-downs: If the reason for the extraordinary write-down no longer applies, the book value must be increased again-up to a maximum of the amortized cost. In practice, this means: If the market value of a property on the balance sheet recovers after an extraordinary write-down, the recovery in value must be reflected in the subsequent balance sheet.

For companies that have invested in commercial real estate in Nuremberg-properties that appreciated in value in the early 2020s and subsequently corrected-this fluctuation in write-downs and write-ups can pose a significant accounting challenge.

Practical Tip for Companies in Nuremberg

We recommend that companies and commercial real estate investors in the Nuremberg metropolitan region regularly compare the book value of their properties with the current market value. If the market value is permanently below the book value-e.g., due to structural vacancy, a decline in the property’s location, or an inflated purchase price-an impairment loss should be considered. While this reduces the balance sheet value, it can offer tax advantages.

Conversely, there is an obligation to write up (§ 253 (5) HGB) if the value rises again. For these valuation issues, we recommend working with a tax advisor specializing in real estate and a certified appraiser for market value determination.

Frequently Asked Questions

Does the lower-of-cost-or-market principle also apply to private landlords?

No. The lower-of-cost-or-market principle is a commercial law principle and applies only to real estate held as business assets (companies required to prepare financial statements). Private landlords who calculate their income using the cash basis method are not affected. For them, scheduled depreciation applies regardless of the current market value. A private landlord cannot write off their rental portfolio on an unscheduled basis, even after a sharp decline in prices.

When is there a permanent impairment?

A permanent impairment exists if the market value is expected to remain below the book value in the long term-mere market fluctuations are not sufficient. The tax authorities generally require that the impairment persist for at least half of the remaining useful life. An expert opinion is the most reliable evidence and should be prepared by a publicly appointed expert.

Do I have to record a reversal of impairment if the value rises again?

Yes. According to Section 253(5) of the German Commercial Code (HGB), there is a requirement to reverse impairment: If the reason for the impairment loss no longer applies (the market value rises again), the book value must be written back up to a maximum of the amortized cost. For tax purposes, a parallel requirement to reverse the write-down applies under Section 6(1)(1), Sentence 4 of the German Income Tax Act (EStG).

IFRS versus HGB: Different Approaches to Real Estate Valuation

Capital market-oriented companies that prepare their financial statements in accordance with the international financial reporting standards IFRS do not apply the lower-of-cost-or-market principle in this form. Under IAS 40 (Investment Property), there is a choice between the cost model (similar to HGB) and the fair value model, under which real estate is valued annually at current market value-both increases and decreases in value are recognized directly in the income statement.

This difference has significant consequences: Real estate companies reporting under IFRS can report high book gains from the appreciation of their portfolios during boom years, but must also immediately recognize losses in the income statement during market corrections. The years 2022 and 2023 demonstrated this impressively, as large residential real estate companies were forced to take significant write-downs on their portfolios.

For medium-sized real estate owners and companies in the Nuremberg metropolitan region that prepare their financial statements in accordance with the German Commercial Code (HGB), however, the lower-of-cost-or-market principle offers a certain degree of protection against forced write-downs during temporary market fluctuations.

Real Estate Valuation as Part of the Annual Financial Statement Audit

For companies required to prepare financial statements that own real estate, the lower-of-cost-or-market principle is a regular topic in the annual financial statement audit. Auditors scrutinize whether the book value of real estate corresponds to the lower fair value-and, if impairment is suspected, demand appropriate evidence.

In practice, it is therefore advisable to have a market value analysis of the real estate on the balance sheet conducted by a qualified appraiser every two to three years. This provides legal certainty vis-à-vis the auditor, documents the valuation decision, and delivers valuable information for strategic decisions (hold, sell, renovate).

Practical Significance in the Current Market Phase

Real estate markets in Germany-including the Nuremberg metropolitan region-have undergone significant corrections in many segments following the rise in interest rates starting in 2022. For companies that hold commercial real estate, office space, or logistics properties on their balance sheets, the question of the lower-of-cost-or-market principle is therefore becoming increasingly relevant.

Particularly affected are:

• Office properties, whose values have come under pressure due to the trend toward remote work and rising vacancy rates
• Retail properties (retail stores, shopping centers), which have permanently lost value due to structural changes in the retail sector
• Project developments in current assets, where rising construction costs and falling sales prices have eroded margins

Residential real estate in attractive locations such as Nuremberg, on the other hand, has remained at a relatively high level despite the correction, so that impairment losses are less frequently required here. Nevertheless, companies with residential real estate holdings should also regularly check whether book values still reflect current market conditions.

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