property in a fully taxable sale and then use the net proceeds, along with additional equity

capital, to acquire the replacement property. The second option is to take advantage of

Section 1031 of the IRC and exchange out of the existing property and into the

replacement property. The second strategy would allow the taxpayer to defer recognition

of the taxable gain that has accrued on the existing property. The net present value of the

sale-purchase strategy, NPVSALEt, assuming all-equity financing, can be represented as

 S(1- o)I, DEP,," p,2 SC -2 ,gCG 2, ZdREC4P,2,s
NPVSALE, =(ATSP, -pt) +- 7, (1)
 z=1 (1+k)' (1+k)"
where:
 ATSP' = the net after-tax proceeds from the sale of the existing property at
 time t;
 Pt = the acquisition price of the replacement property at time t;
 ro = the taxpayer's marginal tax rate on ordinary income;
 I, = the expected net cash flow of the replacement property in year i of
 the expected n-year holding period;
 DEP2," = allowable depreciation on the replacement property in year i,
 conditional on a sale-purchase strategy;
 k = the required after-tax rate of return on unlevered equity;
 P 2 = the expected price of the replacement property in year t+n;
 SC,, = expected selling costs on the disposition of the replacement
 property in year t+n;
 Tg = the tax rate on capital gain income;
 CG,2 = expected capital gain income on the sale of the replacement
 property in year t+n, conditional on a sale-purchase strategy;
 Td = the tax rate on depreciation recapture income; and
 RECAP,, = depreciation recapture income on the sale of the replacement
 property in year t+n, conditional on a n-year sale-purchase
 strategy.

 The first term on the right-hand-side of equation (1) represents the additional equity

capital that must be invested at time t under the sale-purchase strategy, and is equal to the

after-tax proceeds from a fully taxable sale minus the acquisition price of the replacement

property at time t. As is detailed below, if the price of the replacement property is equal