where UNDBASIS2, is equal to the acquisition price of the replacement property (p,2)

minus the taxable gain that was deferred at time t (DEFGAINt) by executing an exchange

strategy. DEFGAIN, = CG} +RECAP,', and DEP2 e is equal to


 12 -LP2 DEFGAIN )
 DEP2,e _(1 L D t (14)
 RECPER

where L^ is the percentage of the replacement property's acquisition price that is non-

depreciable and RECPER is the allowable cost recovery period for the existing property.

Note that reducing the tax basis of the replacement property by the amount of the

deferred gain insures thatDEP2,s > DEP2 ". Total taxes due on the sale of the

replacement property in year t+n, conditional on an exchange strategy at time t, are

expected to be

 TDS, = cgCG, +rRECAP2. (15)

 The taxpayer should exchange into the replacement property if the net present value

of the exchange strategy [equation (11)] exceeds the net present value of the sale-

purchase strategy [equation (1)]. To determine the net present value of the sale-purchase

strategy, equations (7) and (8) are first substituted into equation (6). Equations (2), (3),

(4), and (6) are then substituted into equation (1). To determine the net present value of

the exchange strategy, equations (12), (13), and (14) are substituted into equation (11).

Finally, subtraction of equation (1) from equation (11) produces the following expression

for the incremental NPV of the exchange strategy