Wednesday, January 21, 2009

Real Estate Depreciation

When I started this blog, I determined that I would refrain from commenting on current and proposed tax policy because I'm just a student and really don't know what I'm talking about. There's really nothing much more unbearable than reading through a know-nothing's pontifications on the state of the universe. However, I've got two cents burning a hole in my pocket, so I'm going to throw 'em in. [I'll try to keep this from becoming a habit.]

Today's post by Professor James Maule on his MauledAgain blog discusses a proposal, articulated in a 2007 post by Robert Flach on his Wandering Tax Pro blog, to end the IRC's allowance of real estate depreciation deductions. From every angle this makes good economic sense; the deduction may have helped contribute to the overinflation of the housing market, and there is no reason to allow a deduction on an asset that is in fact appreciating in value. However, after realizing what a good idea discontinuing the deduction would be, one realizes the political impossibility of doing away with it.

My first thought was that if we can't outright do away with real estate depreciation we must be able to find away to counteract its effect. My second thought was to toughen the recapture rules -- perhaps by upping the tax paid on recapture -- and giving the option to depreciate as much (up to a point) or as little as the taxpayer thinks is economically accurate with the threat of penalties if they are found to have deducted too much when they eventually sell the property. My third thought was that this is a dumb idea (for a number of reasons that I won't waste your time by enumerating).

So here is my current thought: why not continue to allow taxpayers to profit from the fiction that their real property depreciates in value so long as there is no evidence to the contrary? The catch would be that a property value assessment for local property tax purposes would count as evidence to the contrary. If a tax assessment showed that a taxpayer had claimed too much in depreciation deductions since the purchase or previous assessment, then the service could either 1. require taxes on recapture to be paid immediately, or 2. require the rate of depreciation be adjusted match the current trend as evidenced by the change in value since the property's purchase or previous tax assessment. Certainly there are quite a few issues to work out before attempting to implement such a policy (and I won't waste your time by typing out my current list), but I cannot think of any that would be an outright deal-breaker.


  1. Interesting idea, but read my many posts about the absurdities of the real estate tax assessment system in Pennsylvania, where assessments are but a fraction of true value, are disproportionate from property to property and county to county, and have provided all sorts of opportunities for political chicanery. My Monday post will reference this topic (among others) with links back to previous posts. --Jim Maule

  2. Why do the solutions need to be so complicated? I am a pretty simple guy and generally find that the simplest solutions are the most elegent and most efficient.

    Adding here and subtracting there are great for the Lawyer and CPA Full Employment Act, and add little value to those of us who are elbow deep in trying to make a real enterprise work.

    I think it similiar to the situation with the high fuel prices this past summer.

    The issue was NOT the absolute price of the fuel. The issue was the uncertainty of the price.

    If the gasoline fairy had plunked her magic wand and said, "Gasoline will stablize at $5.00" a gallon." poof!) there would have been frustration. There would also have been stability. Nothing makes me more itchy than instability or inpredictability.

    So, while you go tweeking the tax code: people pay attention and expect the worst.

    Make it simple. Make it easy. Make it transparent.

  3. Professor Maule,
    I appreciate the comment, and as I know almost nothing about real estate tax assessment I will not comment further at this point. I'll look forward to reading your post on Monday.

    I completely agree that in most things -- and perhaps even more so in taxation -- simpler is better. However, in the case of real estate depreciation deductions the simplest/most elegant/optimal solution (to discontinue the allowance of real estate depreciation deductions outright) seems to be politically infeasible. My less-than-elegant idea was an attempt to realize some of the benefits of the optimal solution without having to clear quite so high of a political hurdle. I'd be interested to hear your thoughts on what might be a simpler/better solution.

  4. Actually, it will be my Wednesday post! Today's post was the "catch up" post.

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  6. I think the trick here is to not make everything colourful. Although some of these get away with it.