A day after the New York Times reported Donald Trump paid just $750 in federal income tax in 2016 and $750 again the following year, the president took to his favorite medium to deny the claims.
“I paid many millions of dollars in taxes, but was entitled, like everyone else, to depreciation & tax credits,” Trump said on Twitter in response to the Times’ story.
While real estate developers have a number of special tax privileges at their disposal such as 1031 exchanges, debt forgiveness and refinancing, depreciation is perhaps their favorite. Trump’s senior adviser and son-in-law Jared Kushner used depreciation to pay almost no income taxes between 2009 and 2016 while his estimated net worth rose fivefold, to nearly $324 million, according to an earlier report in the Times.
Depreciation allows developers like Trump to say they are losing money on paper even if their real estate assets are increasing in value. It helped lower developers’ average effective tax rate to 2.19 percent, according to data released early this year by Aswath Damodaran, a professor at New York University.
“Real estate investors can go years and years without paying taxes,” said Steve Wamhoff, the director of federal tax policy at the left-leaning Institute of Taxation and Economic Policy.
The concept of depreciation is simple: Buildings and equipment decline in value as they age. With things like cars and machinery, this makes sense because they wear down or become outdated. But real estate generally becomes more valuable over time, especially in markets such as New York City. (Depreciation cannot be taken for land itself, only for the improvements on it.)
The IRS allows businesses to deduct a certain portion of a property’s value every year until it reaches zero. For residential rental properties, the depreciation period is 27.5 years and for non-residential it is 39 years, according to the IRS.
“You build the building, all the costs get capitalized into it, then you depreciate it over a period of time,” said Josh Kaplan, a partner in the Miami office of Bilzin Sumberg who focuses on tax and corporate law. “It is extremely common in just about every real estate deal as long as it is a business.”
Although depreciation offsets taxable income, the owner of the property does have to pay tax upon selling it for more than he paid. In calculating the taxable gain, the depreciation is not factored in — a policy known as depreciation recapture. But developers pay no more than 25 percent tax on these gains, not income tax rates, which can be as high as 37 percent.
Adding to these benefits, a provision in the 2017 tax reform allowed depreciation of assets faster than before. And this year the CARES Act, passed as pandemic relief, accelerated that bonus depreciation even more, and broadened it to include interior renovations such as work on a new lobby.
“When you think of huge office towers, the scope of those qualified improvements can be in the tens of millions of dollars each year,” said Lynn Afeman, a managing director in KPMG’s national tax office, in an interview earlier this year. The change offers significant tax savings to real estate owners, she said.