glennds wrote: ↑Sun Aug 16, 2020 12:51 pm
vnatale wrote: ↑Sun Aug 16, 2020 11:18 am
Sorry. How many corporate or entity tax returns have you prepared?
I'll try to explain it to you simply.
For cash I buy a building for $1,000,000. Pretend I hold it for 20 years and am able to fully depreciate it for tax purposes over that same 20 years, giving me a depreciation expense of $1,000,000.
Over those 20 years I had $2,000,000 in income and $2,000,000 in expenses (not counting depreciation expense).
So I break even on the expenses aside from depreciation. From that I have NO extra money in my pocket.
The only way I have a tax loss from this is if my building is now worth ZERO. Which means that tax loss of $1,000,000 was due to me getting nothing back from my initial $1,000,000 investment. Therefore, my tax loss of $1,000,000 equals a real cash loss of $1,000,000.
Feel free to explain to me with some detail how: "Tax losses are part of how you make money in real estate."
Vinny
Under this scenario, your basis in the building would be zero, so yes, you would have a cash loss of $1 million representing the difference between your purchase price and net sales price (we'll ignore selling and closing costs). The net gain would be $0 because your basis was zero and the sales price was zero. However you would owe ordinary income on the recapture of the accumulated depreciation which would be taxed at ordinary income rates. So in the end it would be a taxable transaction and a pretty bad investment, but then it is highly unusual that a real estate asset would drop in value over 20 years by 100%.
WiseOne's point may have been that in the intervening 20 years of your example, there was an annual loss for tax purposes due to the depreciation deduction claimed each year of the holding period which is a benefit to the taxpayer even if not being totally used and carried forward. I don't like the term "making money", but rather I would call the depreciation deduction a tax deferral feature. HOWEVER, a sophisticated real estate investor like Trump would surely continue to roll the (gain and) accumulated depreciation forward by engaging in a 1031 transaction rather than a conventional sale and in this way perpetually defer the recapture. Not to mention estate planning techniques that allow basis step-up and discounting for estate tax purposes, which "people say" was used extensively when his father died. There are also techniques like cost segregation that can allow for acceleration of certain depreciation classes, and changes to basis due to renovations and other capital investment in the property. The list goes on.
Now imagine your scenario but the building didn't depreciate by 100% and instead appreciated by 5%/year and let's say it was generating a positive cash flow of about $50K/year. I think these numbers are more realistic. At the end of the period, your building would be worth about $2.5MM and you would have earned $1MM in operating cash flow against which you would have incurred no taxes. If you did a 1031 exchange, then you would roll forward and defer your $1.5MM gain and the $1MM in accumulated depreciation and start all over again in a new real estate investment with your carried forward basis. And if you wanted to get your hands on some of your unrealized gain in the form of cash, you would do so by refinancing the building at the appreciated values on a cash-out amount which would not be taxable because it's debt. Very convenient in a time of declining interest rates too.
Not implying that any of this is negative. Congress has permitted these tax features under the Tax Code to create incentive for real estate investment which in turn stimulates the economy.
This is why I feel headlines about Trump's losses can be misleading. This said, I do recall he had some stunning business failures in the 90's most famously involving Atlantic City casinos, so some of his losses may not be so shrewd. Like everything with Trump, there is a case to be made in both directions.
It's been a while since I did any tax returns regarding any of this so I'm somewhat rusty on my knowledge regarding all tax laws for real estate.
Referring to your first paragraph I don't believe that you'd owe any ordinary income on the recapture of the accumulated depreciation.
Assume that I'd sold the building for $2,500,000 and was not considered a "real estate professional". I'd have had a gain of $1,500,000. Further assume I'd held it for over a year. Normally, for a capital asset you'd think the whole $1,500,000 would then be long-term capital gains. Instead, the long-term capital gains would only be $500,000 with the remaining $1,000,000 being ordinary income due to as you describe above -- recapture of accumulated depreciation.
Therefore, my memory says that the recapture only comes in to play WHEN you actually have a gain.
Yes. After I wrote my simple example I thought that for certain someone like Trump would have engaged in section 1031 or like kind exchanges. However, those are not so easy since you have to find a partner to swap properties with, its value has to exceed the value of your property, and, finally, a lot of deadlines must be met to be effective.
But as you pointed out, it's all tax deferral. If you are not gifting it and you are "cashing" out of your real estate investments as part of your retirement plan, then you are now going to finally pay taxes on all those deferred gains.
I need to think more about the estate tax purposes since I have much less familiarity with that aspect of tax law.
Cost segregation is generally done to either expense what would otherwise be a capital asset or to achieve a shorter life for the capital expenditure. I think this is all just a nuance to the basic concept of depreciation for real estate.
Let me think about your imagine scenario.
If it generated a positive cash flow of $50,000 a year then this would be the imagine scenario:
Income $2,000,000
Expenses $2,000,000
Depreciation $1,000,000 (part of the $1,000,000 of Expenses)
Income - Expenses = $0
Adding back depreciation gives $1,000,000 in cash flow (albeit not counting the original $1,000,000 you invested)
But I'm now NOT generating a tax loss of $1,000,000. I'm break even. So I'm not seeing how this imagine scenario fits with Trump having a ten year loss of in excess of $1 billion?
What your imagine scenario does is allow one to NOT lose money and generate a lot of income that is deferred. That was NOT the hypothetical Trump scenario which started this particular discussion.
Getting back to the estate part you brought up. It looks like Trump was up to his typical tricks of fraud - by severely undervaluing the value of the property transferred to him (and his siblings) by then, correspondingly, severely reducing the gift tax.
https://www.nytimes.com/interactive/201 ... trump.html
Vinny
