Optimal Holding, the Cost of Capital, and Tax Policy

摘要

The effects of tax policy on the user cost of capital for real estate, a significant secondhand market which involves the measurement of economic depreciation, are examined. In the absence of taxes, the value of a property to an investor is equal to the sum of discounted gross rents and receipts upon sale. The effect of taxation is to subtract from this sum taxes at the ordinary rate on both the gross rent and the gain or loss from the property sale. To this difference are added three components: (1) the discounted value of the investment tax credit received, plus the value of deferring repayment of the initial credit received; (2) the value of deferring recapture of depreciation at the ordinary rate; and (3) the value of the conversion of ordinary income to income taxed only at the capital gain rate. The size of these components depends on the recapture provisions for the class of property. Their magnitude is least with no investment tax credit and complete recapture of depreciation, and greatest with a tax credit and no recapture either of depreciation or of the credit. Assuming rental income and the investor's tax rate are constant and there is no gain or loss on sale, it was demonstrated that if the property is not sold by the end of its useful life, it would be held indefinitely. With complete recapture, the property would never be sold unless there is a tax credit. With incomplete recapture, it would not be sold before the end of its useful life unless there was a tax credit or accelerated depreciation. Further, it was determined that the holding period will be shorter and the user cost of capital lower (1) the higher the investment tax credit, (2) the higher the acceleration in the rate of credit, (3) the lower the capital gain rate, (4) the more accelerated depreciation, and (5) the lower recapture of depreciation at the ordinary rate. These factors combine to motivate an investor to sell property while it is still productive. Mathematical equations are provided, along with footnotes and a bibliography. (Author abstract modified).