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Avoid, Not Evade, Taxes

Avoid, Not Evade, Taxes
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Friday, 10 May 2019 12:29 PM Current | Bio | Archive

Kudos to the New York Times. America’s self-described “newspaper of record” recently discovered this week that President Donald Trump paid little to no taxes in the late 1980’s and early 1990’s.

It’s almost as though they didn’t hear about his troubles at the time. It’s easy to see why, what with Trump Tower being so far away and so remote from the Times headquarters. Well, maybe not geographically, but culturally.

As the Times may have been unaware at the time, New York real estate prices dropped after a big go-go decade or so. And, being highly leveraged, at one point Trump wasn’t a billionaire so much as he was on the hook for over $1 billion thanks to personal guarantees on now-declining properties.

In fact, by one measure he may have been the poorest person in America in the early 1990’s.

But, with the word “quit” being longer than the word “sad,” he worked things out with his bankers, real estate prices moved higher, and the net worth flipped from a big loss to a big profit.

No stranger to modesty, President 45 even penned a book about his Art of the Comeback. If only the New York Times had a book review section back in those days, they may have heard of it!

But we’re not here to bash the Times for once again discovering a story decades after it already discovered it the first time. The media and Trump are like an episode of Tom and Jerry with less classical music.

As always with these political throwback “tempest in a teapots,” though, there’s a bigger lesson here for investors.

It has to do with taxes. How could a real estate developer manage to do so much while still losing so much money according to his tax returns? Enter the United States tax code. While it’s changed a bit since the 1980’s—particularly with some changes in the mid-1980’s that really hurt real estate development—the fact of the matter is, Uncle Sam is pretty forgiving on real estate.

As a homeowner you can deduct the interest on your mortgage, the kind of policy that lets folks pay for a bigger and more expensive home than they could otherwise afford. But once you get into renting out property, all sorts of things become possible.

For instance, I have rental properties. They have positive cash flow against all the typical monthly expenses—mortgage, property insurance, and so on. Even adding in the occasional repair and maintenance here and there, worst case scenario I break even between the rental income and my expenses. Eventually, the mortgage will be paid off and I’ll have a monthly income out of that akin to an annuity.

Since I’m young enough that I don’t expect to see a dime back from Social Security, the long game here works for me. I’ll want that bigger stream of income later. But while it sounds like a struggle now, real estate works even better thanks to Uncle Sam and those real estate tax breaks.

Enter deprecation. For a residential property, the cost of the building (excluding the land), can be gradually written off over a period of 27.5 years. In theory, that reflects the fact that the building may age to the point where it has to be entirely replaced. Is that what happens in reality? If it were, we’d have no buildings made after 1992!

Depreciation can allow you to write down the building cost to zero. But if you go and sell the property, now you have to pay taxes on gains from the depreciated value in the future. That’s why so many real estate investors follow a buy and hold model. Depreciation can turn a flat or low-cash flow property into one with better returns after taxes year after year—but the taxman expects a bigger cut down the line, should the property ever be sold.

And we’re only talking about developed properties and federal taxes in general. A smart developer would also seek tax abatements from local communities to construct new buildings there. That was part of Trump’s strategy in the 1980’s.

More recently, Amazon (AMZN) was looking for some sizeable tax abatements for its new headquarters. They did so with the understanding that the jobs they brought, both directly through employment and indirectly through other nearby services, would more than offset the tax breaks to get things going in the first place. Queens may have passed, but Amazon found a solid deal elsewhere where everyone wins.

The point is that you should avoid taxes wherever possible. Evading taxes is illegal. But the tax code, even today, is generous enough to give just about anyone a break provided they do things the way the government wants them done.

And if you really want to play the game on a big scale, an astute legal team can find even better ways of staying inside the law but letting you keep as much income as possible. It’s possible to be asset rich, and even cash-flow rich, but have little net income for the government to tax.

If real estate isn’t your thing, contributing to tax-advantaged retirement accounts like an IRA or 401(k) plan can lower your taxes. The tradeoff? You can’t get that money until later. But it still means less taxes and more investment power now, and that’s a tradeoff worth taking.

Just one word of caution: Don’t get overleveraged. Reducing your tax burden is about increasing your wealth over time, not setting yourself up for a big failure!

Trump may have been the master of coming back from a bad stroke. Most folks don’t have the tenacity to stick through the tough and painful adjustments necessary to recover from a setback.

Andrew Packer is a Senior Financial Editor with Newsmax Media. He currently writes the Insider Hotline investment advisory, serves as investment director for the Financial Braintrust, and writes the monthly newsletter Crisis Point Investor.

© 2019 Newsmax Finance. All rights reserved.

   
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Reducing your tax burden is about increasing your wealth over time, not setting yourself up for a big failure!
avoid, evade, taxes, investors
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2019-29-10
Friday, 10 May 2019 12:29 PM
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