to the price of the existing property, then ATSP,' P,2 is equal to total taxes due on the
sale of the existing property, plus total selling costs.
The second term on the right-hand-side of equation (1) represents the cumulative
present value of the replacement property's net cash flows from annual operations, plus
the present value of the annual tax savings generated by depreciation. Annual
depreciation, DEP2 ", is equal to
DEP2 = L (2)
RECPER
where P2 is the acquisition price of the replacement property, L is the percentage of P2
that represents non-depreciable land, and RECPER is the allowable cost recovery period
for the replacement property.1 Since the replacement property is purchased with the
proceeds from a fully taxable sale, the original tax basis of the replacement property is
"stepped up" to equal the total acquisition price, P2, thereby maximizing allowable
depreciation deductions over the expected n-year holding period.
The third and final term on the right-hand-side of equation (1) represents the
expected after-tax cash proceeds from the sale of the replacement property at the end of
the assumed n-year holding period. Deducted from the expected selling price of the
replacement property at time t+n are the following: expected selling costs (SC,2), the
expected capital gain tax liability (cg CG,2 ), and the expected depreciation recapture
tax (dr RECAP, ).
1 Congressional legislation has repeatedly altered the period of time over which rental real estate may be
depreciated. Currently, residential real property (e.g., apartments) may be depreciated over no less than 27
and 1/2 years. The cost recovery period for nonresidential real property (e.g., shopping centers, industrial
warehouses, and office buildings) is 39 years.