Our Tax Code is Broken When it Comes to Real Estate

Normally, the basic idea of our tax system is that you figure out how much you profit on a transaction, then pay tax as a percentage of that profit. Unfortunately, our tax code is broken, and people like Jared Kushner have taken advantage of that.

The simplest explanation for this is that the tax code is very complicated, and it isn’t the responsibility of taxpayers to make sure they pay as much tax as possible. In fact, many will argue, it’s the opposite– that taxpayers should pay as little as legally required. While this may be expected to some degree, the extent to which many millionaires have gone to contribute as little as possible to the running of this country is questionable at best, and unpatriotic at worst. This is because the tax code allows for some ambiguity to fit as many taxpayers as possible. In the process, this ambiguity has provided loopholes for those wealthy enough to pay a lawyer to find them. Let me explain:

Say, for example, I buy a fancy car for $50,000, then decide to work as an Uber driver. If in the first year I make $40,000, after paying for gas and other expenses, I will physically have $10,000 less than I had at the beginning of the year. But, this is actually a pretty good deal since I still have the fancy car. Since the car will last more than one year, I can’t deduct the full cost of the car when I calculate my profit to figure out how much taxes I should pay. While the actual rules are a little more complicated, let’s say that I get to deduct the full $50,000, but over a period of five years. Then each year (if everything else is the same), I would pay taxes on a profit of $30,000, and at the end of the five years, I will still have the fancy car (to sell, keep, etc.)

This aspect of the tax code is fairly straightforward, and as far as being one-size-fits-all, works pretty well. So, let’s make it a little more complicated. Say I get a car loan. Instead of paying the $50,000 for the car, I make payments of around $12,000 per year (the first year might be $4,0000 in interest, and $8,000 in principal). Now, I still have $40,000 in revenue, but my expenses include $4,000 in interest and $10,000 in depreciation.

In cash, I have $28,000 more than I started the year with. On my tax form, it says I only made $26,000. So, I’m already getting a pretty good deal here, and this kind of makes sense. In the example, I really did pay $50,000 for a car and the car really will (eventually) be used up. You could make an argument about deducting the $50,000 at the beginning, or at the end, but dividing it up and taking part of the deduction each year is certainly at least reasonable.

Now, let’s switch from Uber drivers to real estate magnates. Say I buy a $50 million office building– financing the whole thing with an interest only mortgage at 7%. Then, say I rent it out for $5 million per year. The office building (let’s just say) is depreciated over 25 years, and we will say it costs half a million dollars per year to operate (doormen, heat, etc.). Now for this example, in cash I am up $1 million per year (the rent minus the mortgage payments and expenses). For tax purposes, I get an extra deduction of $2 million per year from the building depreciation, so I report to the IRS that I do not need to pay any taxes at all! This is because:

Revenue Expense
Rent +$5 million
Interest Only Mortgage -$3.5 million
Operating Cost -$0.5 million
Annual Depreciation -$2 million
Revenue Subtotal Expense Subtotal
+$5 million -$6 million
Total Net Income -$1 million

I can even have real income of $1 million from other stuff, and still pay absolutely zero in income taxes. This is not fair, because the depreciation (on a New York City office building) does not represent a real cost. That office building will be worth a lot of money in five year or twenty-five years, or whenever.

This is where the tax code fails to do its job. Instead of ensuring this sort of tax avoidance does not occur, the tax cuts passed last year further entrenched estate depreciation deductions, even when unnecessary. This lack of nuance is not by coincidence, or oversight. Rather, it was by design. That Trump’s son-in-law is the latest political official exposed for paying less tax in proportion to income than the average American should not surprise anyone. That Republicans are working to pass further tax cuts that will enrich Kushner and his father-in-law further should. Have they no shame? And if not, have the middle and working class not had enough? This November, we need to elect representatives that don’t scheme in order to pay less in taxes, but are working to fix the system to make it fair for everyone.

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