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Abstract
This paper uses a hedonic pricing model and National Council of Real Estate Investment Fiduciaries data to estimate economic depreciation for multi-family real estate. The findings indicate that investment grade multi-family housing depreciates approximately 2.7% per year in real terms based on total property value. This implies a depreciation rate for just the building of about 3.25% per year. With 2% inflation, this suggests a nominal depreciation rate of about 5.25% per year. Converted into a straight-line depreciation rate that has the same present value, this suggests a depreciable life of 30.5 years-as compared to 27.5 years allowed under the current tax laws. Thus, these laws are slightly favorable to multi-family properties by providing a tax depreciation rate that exceeds economic depreciation, which is in part due to inflation that has been less than expected during the past decade.
Introduction
The Economie Recovery Tax Act of 1981 (ERTA81) and the Tax Reform Act of 1986 (TRA86) dramatically altered the timeline of returns to real estate by first shortening and then lengthening the tax depreciation rates for multi-family residential and nonresidential (commercial and industrial) real estate. ERTA81 provided a 15-year depreciable life for structures (both residential and nonresidential) and allowed a 175% declining balance depreciation method to be used. Legislation in 1984 and 1985 increased the life to 18 years for residential and 19 years for nonresidential real estate. TRA86 further increased the depreciable life to 27.5 years for residential and 31.5 years for nonresidential real estate-attempting to create a depreciation system for real property structures that would be consistent with the economic depreciation of property in general. Changes to the depreciable life of property and/or leasehold improvements to property are once again being considered. The Tax and Trade Relief Extension Act of 1998 directed the United States Department of Treasury (Treasury) to study and make recommendations on the current recovery periods and depreciation methods under section 168 of the Internal Revenue Code. At issue is the relationship between market-stimulated economic depreciation and legislated tax depreciation and the potential for inequitable tax burdens due to the inability of tax-based depreciation to match economic depreciation.
In response, the Treasury produced a 130-page report in July 2000 that carefully evaluates current issues in the tax depreciation...