Deloitte: Change Depreciation for Real Estate.

Current property depreciation methodologies are outmoded and need to be revised, argues Deloitte & Touche. In a recent study, the Big Five firm argues that the 39-year nonresidential and 27.5-year residential property depreciation schedule in current tax law simply doesn't provide property owners with a quick enough investment recovery.

The Deloitte study suggests that tax depreciation should be updated to reflect the actual rates at which building investments lose value as they age. Using regression analysis, the firm's consultants estimated from market data the annual rate of loss of value (called economic depreciation) of the original investment in a building. The authors conclude that, if the straight-line method of depreciating an entire structure were retained, the recovery period necessary to make tax depreciation correspond to economic depreciation is 20 years or less. (In this case, regression analysis allowed isolating the effect of age on a building's value from other influences, such as location.)

Under current tax law, found in Section 168 of the Internal Revenue Code, the depreciation deduction for structures doesn't provide appropriate tax benefits because investors are forced to recover their costs more slowly than the structures' actual loss of value. Previous research understated the rate of economic depreciation, and thus overstated the appropriate recovery periods, because it neglected to account for the substantial expenditures devoted to building improvements after original construction, Deloitte says. Spending on these upgrades boosts the value of a building, and thus understates the true rate of loss in the original construction value.

The text of the study is available at www.us.deloitte.com/realest/DepreciationStudy.