Sunday, November 27, 2005

Accelerated Depreciation

Christopher Leinberger, a new professor in the Taubman College of Architecture + Urban Planning, gave a job talk last spring talking about his philosophy and practice of real estate development, as well as some of his research work in that realm. If you go to his Web site,, you can read his article on the 19 standardized products of real estate, or his thoughts on pedestrian-oriented developments. In the course of his job talk, he presented his idea of the 19 standardized products, and talked about financing buildings. One of his points that resonated with me was that in developing buildings, though they were formerly built with a 40-year obsolescence, the prevailing financing horizon is only about 7 years now. The idea stuck with me, though Leinberger offered no explanation for the change. He went on to discuss how these shorter-term financing deals made developers turn to disposable buildings like strip malls with smaller startup costs and the ability to sell or abandon them after the initial profitability period.

I was led to an article on tax policy and real estate development today, where I found an adequate explanation (American Historical Review, October 1996, pp. 1082-1110). With the Wilson-era expansion of the Internal Revenue Code, building depreciation was written in as tax deductible, though regulations were limited. By 1931, deductions claimed by businesses nationwide for buildings and equipment actually exceeded total business profits, nationwide. Thus, in 1934 the tax code was rewritten, establishing "straight-line" depreciation, meaning that the depreciation was assumed to be linear, taken in 40 equal annual increments. After a recession in 1953, the solution for this short-term situation was thought to be a long-term change in the tax code. In order to spur investment in industrial production, the term of depreciation was accelerated so that the life of buildings was taken to be something like 10 years. Another tax provision compounded this so that it really was more affordable to build new than to renovate old. While this may have promoted new construction, this, in conjunction with new developments in cheap, standardized building materials, meant that companies could build for the short term as profitably as they could build for the long term.

Think about every cheap, strip mall, ugly building you hate that took the place of a gorgeous, old, solid building that was torn down. I used to lament the change in the built world as a change in taste -- that people actually wanted these kinds of neighborhoods. In fact, it's tax policy. It all comes back to public policy.


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