As is the case with almost everything we buy (other than baseball cards and fine wine), it depreciates over time. A building is no different, as the property ages its value depreciates. For an owner of an income earning property this depreciation is considered an expense, and may be deducted from otherwise taxable income. The typical standard depreciation on a building’s structure is twenty seven and a half years (See, 26 USC 168(c) and (e)) To spell it out, if someone buys a building valued at a million dollars, the building would “depreciate” roughly $36,363 each year, and after year one, the building will be worth $963, 637.

Market prices however, usually do not reflect this depreciation. Other factors such as market rent and location carry more weight in setting the price. As such, the property that we value at $963,637 after year one, can still usually be sold at the same $1m. To account for this discrepancy the Tax Code requires property owners pay for the depreciation when they sell the property (See, http://www.homebuyerscentre.nationalbank.co.nz). Therefore, in our example, when the property is resold for $1m, the IRS will require the seller pay the taxes on the $36,363 in income that he had claimed as a loss the previous year.

The Code’s solution however, can cause the property to become unsellable after an owner has owned the property for a long time. For example, after twenty seven years the building will have completely depreciated, in other words we’ll consider it worthless. If the owner then sells the property for the market price of $1m, he would need to pay taxes on the entire $1m. Since these taxes only need to be paid if the owner sells the property, it is unlikely he would be offered a price that would be worth it to sell at. In fact many properties today are underutilized due to this issue (think abandoned factories).

To deal with this issue, I would suggest that the depreciation rate be set at a far slower rate. By slowing the depreciation rate, a property will need to have been held by an owner for far longer until it will be unsellable. The upshot of this proposal would likely result in more available properties at affordable prices, and would decrease the risk that properties will wind up underutilized.

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