Dynamic Tax Depreciation Strategies

The tax depreciation decision potentially has significant impact on the prof- itability of firms and projects. Indeed, the depreciation method chosen for tax purposes affects the timing of tax payments, and, as a consequence, it also affects the after-tax net present value of investment projects. Previous research focusses on the optimal choice of depreciation method under the assumption that the de- preciation method has to be set ex ante and cannot be changed during the useful life of the asset. In reality however, changes are allowed under certain circum- stances. This paper develops a dynamic programming approach to determine the firm’s optimal choice with regard to the initial depreciation method, and whether changes of method are proposed in later periods.