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Trump’s Tax Figures Tell Us Little or Nothing
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 General
I knew of a fellow in Pittsburgh that owned a metals scrap yard. For 15 years he only bought scrap never sold. He of course showed a lose for those years. Suddenly the market took off and he made 100 million dollars on his inventory. There a a million stories in the Naked City.
Note that when the property is finally sold (if it is), the tax bases will have been reduced by the amount of the accumulated depreciation..so the owner will pay taxes on significantly *more* than that $200MM to $320MM gain.
Still a very good deal…but points out that you can’t evaluate the tax consequences of an investment without looking at it over its full cycle, which the denouncers of Trump for either (a) not paying taxes, or (b) being a bad businessman (or both) are not doing.
I don’t see why anyone thinks this will hurt Trump. The idea that it costs a lot of money to open a hotel and that you go into debt to do so is not actually a hard concept to grasp.
Thanks for the breakdown. Tax law and accounting are just too much for most to comprehend. It’s easier to just say ‘He has a big house and a gold bathroom so he should be paying lots of taxes every year’.
I wonder how many tax years when he paid millions were intentionally left out of the NYT report?
Of course, the cream of the jest is that the story was widely reported — 30 years ago!
In 1993, the New York Times Company bought the Boston Globe for $1.1 billion.
In 2013, the New York Times Company sold the Boston Globe for $70 million.
Did the New York Times Company report that loss on its taxes?
That is very funny @arizonapatriot
And, for a complex transaction, very clearly explained.
“Pay me now or pay me later” the Taxman sayeth.
Are you taking bets?
Tax law and accounting are too much for me to comprehend. But I say “He has a big house and a gold bathroom so good on him.”
Correct you are! However, you forget who we are dealing with. The dumbed down, headline-reading Hard Left will remain impervious to logic on this or any other matters regarding Trump, immigration, free stuff all the time for everybody, et al.
With the matter of the tax revelations now being a major preoccupation of our Fourth Estate, even I was surprised to find out from Fox News that this indebtedness occurred several decades ago. The lib media made it sound like it happened a year or two ago.
Leftists are utilitarians in ethics; in other words, the ends justify the means.
So they will simultaneously argue his losses prove Trump is a bad businessman before one audience, and that he didn’t pay his “fair share” of taxes before another — or before the same audience on a different day.
I was talking to a friend of mine a couple weeks ago. He has gone from 3 million dollar wealth to 30 million in the last 5 years.
He told me his main line of business has been in the red for 10 years.
He is still doing better than me.
You know who broke the story on national TV about Donald Trump’s finances? Donald Trump.
On the taxes: Continuing the hypothetical in the OP, assume that I sold the property after 10 years for $1.6 billion, instead of refinancing. I’d pay off the $800 million mortgage, and get $800 million in cash from the sale. I would have taken $286 million in depreciation deductions over the first 10 years ($28.6 million per year), so my tax basis would be reduced from $1 billion to $714 million. I would have a capital gain of $886 million. This is in addition to the $220 million in operating revenue that I received over the years.
I’d generally pay tax on the $886 million capital gain at the lower capital gains tax rate, but there’s a wrinkle called depreciation recapture. I think that it works as follows (though this is getting outside my expertise, so if anyone knows better, please correct me).
Because I took depreciation expense of $286 million over the 10 years (as an expense in calculating my taxable income), this amount — $286 million — of my capital gain would be taxed at the ordinary rate, with the remaining capital gain — $600 million — being taxed at the lower capital gains rate. However, remember that I had an accumulated 10-year tax loss carryforward of $66 million. This would reduce the $286 million of the gain taxed at the ordinary rate to $220 million. Note that this precisely equals the operating revenue received over the first 10 years, on which I did not previously have to pay tax because of the depreciation deduction.
If I sold in 1998 or 1999, my ordinary income tax rate would be about 40% (39.6%, technically), and the capital gains rate was 20%. So I would pay $120 million in capital gains tax (20% of the $600 million of the gain taxed at the lower rate) and about $88 million in ordinary income tax (40% of the $220 million of the gain taxed at the ordinary rate).
The overall result would be:
$200 million original investment
$880 million profit
$208 million in taxes
$672 million profit after taxes
Yet until the year of the sale, my tax returns would have showed that I had lost $66 million.
There’s another wrinkle for the next post.
Continuing the hypothetical: Say that I want to sell the property after 10 years for $1.6 billion, but I don’t want to trigger a taxable event. I could do something called a “1031 exchange.”
I’m getting $800 million in cash out of the hypothetical sale in the prior comment. Say I keep $100 million of this, then use the remaining $700 million as a 20% down payment on a new property — one worth $3.5 billion. I can structure the transaction so that I essentially trade the original property for the new one (or more than one, actually).
Now I have a $3.5 billion property with a $2.8 billion mortgage, $700 million in equity. The tax basis of the prior property — $714 million — is my tax basis for the new property as well. I’ll be able to take a depreciation deduction on the new property as well, to keep down my taxable income in future years.
At this point, I’ve paid no tax. I’ve received cash of $320 million, and I have $700 million in equity in a $3.5 billion property.
I may have to pay tax eventually, when I sell the property. Unless I die before I sell it, in which case my heirs get the property with a tax basis equal to the fair market value at the time of my death, and no one ever has to pay income tax on the gain.
Of course, if (when) I die, the estate tax would apply. Tricks that I could use to avoid or reduce the estate tax present an entirely new and complex issue.
Isn’t real estate investing fun!
Sounds pretty neat. I guess I need to start saving up my first $200 million.
Fair tax fixes all this
How?
Does it not allow depreciation expense? Does it not defer taxation of a capital gain until the gain is realized?
I actually don’t think that the present system is broken, at least as described and used in my hypothetical.
15% of your earned income. Period. No depreciation, no deductions, no differentiation between manual labor and capital gains. That would fix it.
Absolutely fascinating. You’ve quintupled my knowledge of real estate. Thanks for this.
It’s the hardest $200 million, in my experience.
The Fair Tax website indicates that it is a sales tax on the sale of new goods and services. If this is the plan, there would be no tax at all on my hypothetical investment. It would be true that I would pay tax on my personal spending, in the hypothetical.
One problem with the fair tax is the transition. In my hypothetical, I bought an existing property ($100 million real estate, $900 million building). If I were to build a new building, there would be a huge tax impact. To match my hypothetical, I would buy undeveloped land worth $100 million, and then would build a $900 million building. The entire cost of the building would be the purchase of “new goods and services,” so I would have to pay tax of 23% — $207 million.
So under the fair tax, I would have to pay $207 billion in tax to build the building, before I’ve earned a dime, raising the total cost of the investment to $1,207,000. This certainly would be a disincentive to build.
Now the effect might not be this big, because the costs of the goods and services required to build the building — $900 million — would include a provisions for income and payroll taxes. So maybe the market price of the goods and services would decline.
John Lennon moved from Great Britain to the NYC scene in part to avoid taxes. In return for his love for his new country, he saw to it that some of the money he would have paid in taxes overseas instead went to programs of his own choosing. One of those times, he donated $ 1,000 to the NYC police department, stipulating it went to buy bullet proof vests for the police. After his death in 1981, Yoko Ono contributed another $ 25,000 to the NYC police department, for their response and handling surrounding Lennon’s murder.####