Taxpayer in 35% Bracket Tax at marginal ordinary income rates ($15,000 x 35%) $5,250 Tax at LTCG rates ($15,000 x 15%) 2,250 Loss of tax savings due to lookback rule $3,000 Exhibit 4 Exhibit Depreciation Recapture A business acquired a warehouse in 1988 for $780,000, depreciated it using straight-line depreciation
and sold the asset for $860,000, when accumulated depreciation totaled $290,000.
Inland Revenue (2007, page 43) indicates that telecommunications equipment with a 10 year economic life would be eligible for straight-line depreciation
at the rate of 15% per year, and this depreciation process would then be completed in almost seven years.
The straight-line depreciation
election can be a trap for the unwary if not made in the year of acquisition.
This method is implemented until the first year in which the straight-line depreciation
of the not-yet-depreciated cost exceeds the depreciation under the declining balance method.
Since this estimation error is simply an artifact of the computational mathematics of straight-line depreciation
compared to the mathematics of nonlinear depreciation implicit in the present value calculation, it can be specified as purely a function of time independent of the characteristics of the property being appraised.
For example, with straight-line depreciation
, depreciation in the first year is equal to depreciation in the second year, which is equal to depreciation in the third year, and so on.
Equation (9) makes it clear that the two paths are linked, and it is well known that the one-hoss-shay pattern of efficiency implies straight-line depreciation
with a zero rate of discount, and a concave pattern with a positive discount rate.
To generate these data, we used a straight-line depreciation
of 7 years and the rule of thumb of 10% of the initial capital costs as the expense for an annual maintenance contract.
is used with a $100,000 reduction for nondepreciable costs and a 27.
Because the historical cost accounting convention used for real estate assets utilizes straight-line depreciation
(except on land), such accounting presentation implies that the value of real estate assets diminishes predictably over time.
If we assume, for simplicity, that the useful life is 40 years and straight-line depreciation
was being used, the owner would take a $10,000 tax deduction each year against his income.
1250 gain, equal to the amount of the straight-line depreciation
allowed for the property, limited by the amount of net Sec.