Posted by Curt on 27 September, 2020 at 5:51 pm. 3 comments already!

Loading


 
by John Carney

Tax records showing that Donald Trump told the IRS that he lost nearly $1 billion over the course of a decade starting in the mid-1980s highlight the complexity of how the tax code treats real estate investments, but they do not tell us much about the president’s business prowess.

The New York Times reported Tuesday that tax transcripts revealing Trump’s tax filings in the years 1985 through 1994 show the president lost nearly $1 billion, with big losses concentrated in the years 1990 and 1991.

“Mr. Trump lost so much money that he was able to avoid paying income taxes for eight of the 10 years,” the Times reported.

That may be true, although White House spokespeople have said the report is not accurate, and the Times has not released the underlying documents or explained the sources of its information. But the bigger contention of the article–that the tax records show Trump is not the artful dealmaker he purports to be–is not supported by the evidence presented.

The article’s most basic problem is that it assumes that the losses Trump reported on his taxes are actual economic losses. But that’s highly unlikely due to the nature of his business. As a real estate investor, Trump was not in a position of a store owner selling inventory below cost and incurring operating losses. Instead, he would have been reducing his reported income by the amount of his interest payments on loans and the depreciation of the property he owned.

This can be a powerful combination that can create what are, essentially, illusionary losses that reduce taxes but inflate an owner’s bank account. What’s more, the bigger the portfolio is of assets owned, the larger the write-offs will be for interest and depreciation.

Take the simplest example. A guy buys an apartment building worth $10 million. For simplicity’s sake, let’s say he bought it with cash. Each and every year for the next 27.5 years he will get to write-down his income by around $370,000. If his tenants pay him $300,000 in rent after basic expenses, he’ll declare a loss of $70,000 on his taxes. His net worth has declined on paper, but he has $300,000 more in cash every year. And if the rent payments ever exceed the depreciation amount, he’ll get to use those old accumulated losses to offset the new income.

In the real world, of course, things are more complicated than our simple example. Buildings are bought with loans, which require interest payments that count as business expenses and reduce both actual income and taxable income. And there are other operating expenses associated with upkeep and maintenance.

So imagine our guy took out an $8 million mortgage at five percent, paying $2 million cash. Now he’s got to pay $400,000 in mortgage payments. He wants to make at least that much so he charges tenants an aggregate of $425,000, which after upkeep comes out to $410,000 of net income. (Remember, if the bank didn’t think he could make more in rent than the mortgage payment, it probably wouldn’t have lent him the money.) The interest payment on the loan–let’s call it $390,000–is deductible from his income, leaving him with $20,000 in net income. He gets to keep that and pay no taxes on it, however, because he still gets to apply the $370,000 depreciation charge. He tells the IRS he lost $350,000.

Under our tax code, ordinary business expenses can be deducted in the year they are incurred. But when a business pays for a long-lasting item expected to produce income–like machinery, vehicles, or an apartment building–it is considered a capital investment. Instead of getting to write-off the cost all at once, the business is required to write it off over the course of decades. After the 1986 tax code, this was set at 27.5 years for residential real estate.

The combination of depreciation and interest deduction was so powerful an engine for creating paper losses that this became one of the most popular tax shelters in the 1980s, in part because the early Reagan tax cuts dramatically slashed the depreciation timeline, which allowed for bigger deductions. It was so popular and drove so much money into U.S. real estate that prices exploded higher–with dire results when the bubble burst in the late 1980s. In the 1986 tax overhaul, Congress sought to limit the ability for outside investors in real estate deals to set off income from their other businesses with losses in real estate. Doctors couldn’t reduce their reported medical income with losses from real estate.

But that reform would have had very little direct effect on Trump, whose primary income was from the real estate that generated the losses. He would have been using depreciation and deductions from real estate to offset income from real estate, which is perfectly fine and not a questionable tax shelter at all.

The president indicated Tuesday that something like this is exactly what explained his tax losses:

Read more

0 0 votes
Article Rating
3
0
Would love your thoughts, please comment.x
()
x