The New York Times has revealed that Trump used excessive business losses to avoid, and evade, federal and state income taxes.
A portion of the losses come from fraudulently claiming personal expenses as business deductions. Trump has clearly cheated on his tax returns and should be indicted for tax fraud. But a large percentage of Trump’s losses comes from depreciation of real estate - a perfectly legal but not, in my personal opinion, “legitimate” business tax deduction.
While it is truly a controversial opinion, as I have said often in the past, here and elsewhere, I sincerely believe that we should do away with the business tax deduction for the depreciation of real property - fixed property, principally land and buildings. The depreciation of real property is a “phantom” expense and distorts the economic reality of the investment activity. It allows an investor with an actual economic profit to claim a deductible tax loss and avoid, or in my opinion evade, income taxes - at least temporarily (depreciation must be "recaptured", sometimes at a lower tax rate, when the property is sold).
Let me repeat my argument.
According to the IRS, depreciation is “an income tax deduction that allows a taxpayer to recover the cost or other basis of certain property. It is an annual allowance for the wear and tear, deterioration, or obsolescence of the property”.
Let us look at depreciation from the point of view of the Income Statement of a business or rental activity. Basically, if you purchase an asset that will last more than one year you spread the cost of the asset over its “useful life”. You purchase a new computer. You certainly do not purchase a new computer each year – you expect that it will continue to provide service for several years. So, you divide the cost of the computer over a period of years to reflect this fact, and to properly report the “economic reality” of the purchase.
If you deducted the full cost of the computer in the year of purchase this would distort the true cost of doing business. Since you generally purchase a new computer every five years, deducting the cost over a five-year period “more better” represents the cost of operations. But you do not purchase a new office building every 27.5 or 39 years because the old building is obsolete or no longer functions.
Another way to look at depreciation is from the Balance Sheet perspective. When you purchase an asset that asset has value to you. You trade the asset of cash for the asset of a computer. If you sold your business the value of the computer would be included in the value of the business. As an asset ages its value drops. A two-year old computer does not have the same value in the market as a comparable brand-new computer. Depreciation is used to reflect the drop-in value of the asset.
A building has a life of much more than the 27.5 or 39 years over which depreciation is currently allowed. The building I lived in several years ago was 100 years old at the time, and is still going strong. And, for the most part, the value of real estate does not drop in value over the years. If properly maintained its value will generally increase. My parents purchased their first home for $13,000 and sold it many years later for $75,000 (and they were robbed). Granted real estate values can go down due to market conditions, but this is the exception and not the rule. So, for all intents and purposes, the value of real estate does not “depreciate”.
Real estate is an investment, just like stocks, bonds, mutual funds, etc. You invest in rental real estate because you expect the building to increase in value over time, often more so than stocks and mutual funds, and because it generates “dividends” in the form of net “in pocket” rental income. The deduction for depreciation of real estate is like allowing those who purchase stock to depreciate the purchase price of the stock as a deduction against the dividends paid out.
Depreciation of real property is a “tax expenditure” – “revenue losses attributable to provisions of the Federal tax laws which allow a special exclusion, exemption, or deduction from gross income or which provide a special credit, a preferential rate of tax, or a deferral of tax liability.’’ This deduction represents federal, and state, revenue losses in the millions, if not billions, each year.
So, what do you think?