A Note on Taxes and the Capital Structure of Partnerships, REITs, and Related Entities

Jaffe (1991) shows that the value of partnerships and REITs is generally invariant to leverage, although certain tax law provisions can result in an inverse relationship between value and leverage. This paper extends Jaffe's analysis to consider recourse and nonrecourse partnership debt, and special allocations of tax items financed by borrowings. It is shown that the relationship between value and leverage for S Corporations is similar to REITs with one added situation where value is inversely related to leverage. Finally, transaction costs can allow for a positive relationship between partnership leverage and value, a situation not addressed by Jaffe.