Taxation, Rental Income, and Optimal Holding Periods for Real Property

This paper presents a formula for the market value of real property that incorporates the tax treatment, financing, and holding period for the property. The formula gives the market value, rental income, holding period, and rate of return that are mutually consistent. The formula essentially shows that determining the market value of real property is identical to the pricing of a bond. The formula is used to examine the effect of the 1986 Tax Reform Act on both residential rental and commercial property. Rent increases range from 7.3 to 28 percent for residential rental property and 4.5 to 23 percent for commercial property depending on the tax rate assumed for the marginal investor under previous law and the effect of the new law on interest rates. If capital gains taxation were not increased as it was under the 1986 Tax Reform Act, the at-risk rule would cause more frequent turnover of real property. The capital gains provisions prevent turnover.