President Donald Trump has touted his proposed tax bill as a benefit to all taxpayers, particularly the middle income class.  He has also unequivocally stated that his taxes will increase as a result of the new tax bill.


Taking the latter statement first, since Donald Trump has not released his tax returns there is no way of knowing if that claim is true or just more of his usual bluster.  But, based on his penchant for deviation from truth, why should the public believe him unless and until he releases his tax returns and proves the point. The simple answer is the public shouldn’t believe him.


What Donald Trump doesn’t tell the public is that one of the biggest gifts to large real estate owners (and small ones too) but excluding homeowners,  is the ability to depreciate the cost of their physical asset (the building but not the land) This is a “phantom” loss as no out of pocket cash is involved like in the case of real cash expenses and the amount of depreciation charged in a given year is a direct deduction from income in arriving at taxable income.


Depreciation is a myth in the vast majority of instances because it is very rare that, at the end of a building’s “useful life” (the number of years over which tax code allows for depreciation) the building is demolished. What is more common is that at the end of the “useful life” under the tax code or in reality a building is renovated and/or its use is changed or both and it goes on.  On the down side, when buildings are demolished because they have passed their usefulness, the value of the underlying land has often risen by a sufficient amount to offset any loss in value for the demolished improvements.


Depreciation is a gigantic gift to the real estate industry and serves to provide a chunk of tax free income to the property owner. One of the arguments in favor of depreciation was that it induced greater investment and created jobs.  That may have been true once but in an expanding and/or inflating economy, such as the economy today, it is probably not true. And, to make things worse it appears that the Senate version would shorten the depreciable life of improvements which will just increase the benefit to the real estate owners.


To argue that the economy needs the incentive of “quick write off” to stimulate investment (development) and employment doesn’t make sense at a time when the U S is at almost full employment.  As long as there is demand for the end product developers will build and would do so without the incentive of tax free cash from depreciation. However, if “stimulus” is the raison d’être for the depreciation allowance then it might be confined to only new construction not to be passed on to subsequent buyers.  An offset could be the allowance of a 100% write off, in the year incurred, for any tenant improvements and a depreciation allowance for the cost of major renovations or changes of use.


Depreciation of buildings is not like depletion allowances in the natural resource industries.  When oil is pumped out of the ground it is gone and the amount in the well is “depleted”.


There is nothing in the proposed tax bill that even hints at considering eliminating the bonanza of depreciation and, under his tax bill, Donald Trump’s income will still be greatly enhanced by the depreciation tax shelter he and his company receives. Eliminating charging depreciation in real estate as an income deduction in arriving at taxable income should be considered for elimination under the proposed code. The reason it is not proposed is most probably that, outside of the  special  interest groups, the subject is not on the public radar no is it likely to be on the radar of less affluent lawmakers.


It would be interesting to see a study as to the total amount of income tax collected on 100% of the net income before depreciation and the tax collected on the revenue after the deduction of depreciation. The amount would probably be more than enough to make some of the other eliminated tax deductions unnecessary.


Now to the first point, the proposed tax bill does not appear to be a huge WIN for the middle class.  In fact, for a large part of the middle class, it appears, they will pay more taxes. The elimination of medical cost deductions will hit the elderly very hard and will be negative for many real people who will have an increased problem trying to afford their medical bills, even after the more expensive insurance pays its part. The average homeowner could be disadvantaged by possible limitations on mortgage interest and property taxes. Meanwhile real estate developers and investors would potentially receive greater gifts than currently enjoyed. There are other problems but they are minor in terms of public impact assuming that the proposed elimination of State income and property taxes do not survive.


The elected officials should move cautiously and avoid quickly enacting legislation just to prove to the public that they did something that achieved a campaign promise. The elected officials, to protect the public, should insist that each provision of the new tax code does, on balance, accomplish a beneficial result and that all arguments in favor of the legislation are proven out by facts as opposed to rhetoric. As things now stand, the proposed tax bills do not appear to bring any major benefits to the middle income taxpayers that are commensurate with the benefits to the wealthy. The lawmakers they should be diligent in understanding all of the possible, unintended consequences of their legislation.

This entry was posted in Property Developemnt, Property Ownership, Real Estate Economy, Real Estate Investment, Real Estate Lending, REITs, The Real Estate Economy. Bookmark the permalink.

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