I’ve seen a few articles on supposedly new revelations about the President’s taxes between the mid-1980s and mid-1990s, with the general comment being that they show huge tax losses, and the general conclusion being that he is a lousy businessman. I have not parsed the details, and it would likely be difficult or impossible to draw a conclusion about the success or failure of his businesses based on tax return information.
My impression is that most people, including commentators at major news outlets, are completely clueless about the realities of real estate and business investing. I’ve put together a very simplified example to illustrate, involving investment in a single $1 billion property in the late 1980s. Here’s the hypothetical.
Assumptions: $1 billion property; $900 million building value; $100 million land value; 6% interest-only commercial mortgage with an 80% loan-to-value ratio (an $800 million loan); cap rate 7% (this is the implicit rate of return used for valuing the property). The property has a tenant on a 10-year lease, annual rent $78 million, annual net income after expenses, but before interest and depreciation, $70 million. (This is called “EBITDA” — earnings before interest, taxes, depreciation, and amortization. It includes property taxes but not income taxes. Operating expenses and property taxes are about 10% of rental income in this example.) The property appreciates 60% over the 10 years (annual appreciation of about 4.8%, compounded).
My beginning equity is $200 million.
So I invest $200 million and have an $800 million mortgage. The property generates EBITDA of $70 million per year. The annual interest is $48 million, so my cash flow is $22 million/year.
I depreciate the building over a 31.5-year period (the depreciation period applicable in the late 1980s; it is now 39 years). I get an annual depreciation deduction on my tax return of about $28.6 million per year. This means that while I make $22 million/year on the property after mortgage interest, my tax return reports a loss of $6.6 million/year.
At the end of 10 years, I refinance the property on the same terms — 6% interest-only loan at 80% loan-to-value. The property has appreciated to $1.6 billion, so the new loan is $1.28 billion. I get $480 million cash out from the refinance. After the refinance, my equity in the property is $320 million.
Here is the summary of the 10-year results:
(1) Cash flow from operations: $220 million
(2) Cash out from refinance: $480 million
(3) Increase in equity: $120 million
(4) Net loss reported on tax returns: $66 million
So in this hypothetical, I’ve made a profit of $820 million over 10 years. I’ve received $700 million in cash, while my equity in the property increased from $200 million to $320 million. Yet I show a tax loss of $66 million.
So some idiots in the MSM would criticize me as a bad businessman.
It might be possible to glean some of this information from a tax return, but the return would not show anything relating to the appreciation of the property, nor would it show the cash-out that I received from the refinance
This is a simplified example, but based on reasonable figures, with the caveat that the interest rate and cap rate that I used are based on current figures; both might have been higher in the 1980s. In the real world, there would probably not be fixed rent over the 10-year period; expenses could vary; the loan might require some principal payments; receipt of rent might be delayed by a tenant’s financial problems or even bankruptcy; I might refinance more frequently in order to take cash our or take advantage of interest rate declines; expenses could vary for a wide variety of reasons including property or rental tax increases.
In addition, this is a single-property example. My understanding is that President Trump’s holdings in the 1980s and 1990s included many properties and many other business investments.Published in