Optimal tax depreciation with losses carried forward

The choice of depreciation method from among straight-line and accelerated methods can have a significant impact on the present value of expected tax payments. This is a problem that has been studied for decades, with most results indicating the optimality of accelerated methods. Recent research has begun to question this claim by relaxing one of the original assumptions ofpositive taxable income. The situation where net-operating losses may be carried-forward and backward in time and applied to periods where a profit is attained has yet to be studied in detail. This paper will model the situation where losses may be carried-forward and establish the conditions that allow straight-line depreciation to be preferred over accelerated methods. The results are focused around a threshold number of periods of consecutive losses, which are determined by the allowable periods to carry a loss forward. For consecutive losses beyond this threshold, straight-line will always be optimal. When the cumulative depreciation charges up to and including the window are guaranteed to be applied on or before the threshold period, then straight-line will never be optimal.