The Tax Reform Act of 1986 set up a depreciation system designed to equalize tax burdens on different types of assets. The recovery period for nonresidential structures was, however, lengthened in 1993. Economic conditions and practices that may bear on this issue have also changed. Lately, there has been some interest in reexamining this depreciation structure. For example, H.R. 4328 , The Omnibus consolidated and Emergency Supplemental Appropriations Act of 1998, mandated the Treasury Department to study current tax depreciation rules and how they relate to tax burdens. This report provides background information relating to tax depreciation of structures, including a discussion of the methods of measuring economic depreciation. The first section of this report provides a description and history of the treatment of structures under the depreciation system. The second section discusses the very complex problems associated with estimating economic depreciation rates and reviews the evidence from the economics literature on these rates. The third section compares, in light of evidence on economic depreciation, the tax burdens on equipment and alternative types of structures, how that tax burden has changed, and what changes, given economic depreciation estimates, would be necessary to restore equal tax burdens across basic asset categories. The fourth section of the paper discusses whether leverage should be taken into account in setting up depreciation rules (an argument which has been made in the past) and the evidence on leveraging rates across assets. (4) Effect of Tax Rules. Note that current depreciation rules for nonresidential structures produce smaller values than would be appropriate to measure economic depreciation, using these estimates. This evidence, therefore, suggests that debt to asset ratios for structures are not higher than for owners of other assets.
The Tax Reform Act of 1986 set up a depreciation system designed to equalize tax burdens on different types of assets. The recovery period for nonresidential structures was, however, lengthened in 1993. Economic conditions and practices that may bear on this issue have also changed. Lately, there has been some interest in reexamining this depreciation structure. For example, H.R. 4328, The Omnibus Consolidated and Emergency Supplemental Appropriations Act of 1998, mandated the Treasury Department to study current tax depreciation rules and how they relate to tax burdens. This report provides background information relating to tax depreciation of structures, including a discussion of the methods of measuring economic depreciation.
The first section of this report provides a description and history of the treatment of structures under the depreciation system. This analysis indicates that depreciation of nonresidential structures is more restrictive today than at any time since 1953, while depreciation on residential structures is more restrictive than it has been since 1971.
The second section discusses the very complex problems associated with estimating economic depreciation rates and reviews the evidence from the economics literature on these rates.
The third section compares, in light of evidence on economic depreciation, the tax burdens on equipment and alternative types of structures, how that tax burden has changed, and what changes, given economic depreciation estimates, would be necessary to restore equal tax burdens across basic asset categories. These estimates indicate that lengthening the life for equipment by about 4 years, or shortening the tax life for structures to around 20 years would restore equal treatment across assets.
The fourth section of the paper discusses whether the use of debt finance, which has been argued to be greater for structures than for other assets, should be taken into account in setting up depreciation rules. This argument which has been made in the past. This analysis suggests that adjusting depreciation rules to address another tax distortion is less desirable than addressing the distortion directly. Moreover, there are other offsetting tax burdens on structures (such as property taxes), which could justify offsetting more generous rules. At any rate, the available evidence does not support the claim that structures are more leveraged than other assets.
This report will be updated as developments warrant.