We’ve reports that Jared Kushner paid no Federal income tax for years. This is obviously going to play well – or not well, dependent upon political views – with the masses. The thing is though it’s an entirely reasonable, even righteous, piece of the tax code. Yes, we should all pay tax on our incomes. If you’re in business then that’s the profit you make and if Kushner is indeed using the piece of tax code stated then it’s not obvious that he has in fact made a profit that he should be paying tax upon.
OK, to specify, not an economic profit that should be taxed and we really do want to try and make sure that it’s economic profit that is taxed, not merely accounting profit.
Jared Kushner, President Donald Trump’s son-in-law and a senior White House adviser, likely paid little or no federal income taxes between 2009 and 2016, the New York Times reported on Saturday, citing confidential financial documents.
The documents were created with Mr Kushner’s cooperation as part of a review of his finances by an institution that was considering lending him money, the paper reported. The paper said that Mr Kushner’s tax bills reflected the use of a tax benefit known as depreciation that lets real estate investors deduct part of the cost of their properties from their taxable income.
The report said that nothing in the documents reviewed “suggests Mr. Kushner or his company broke the law.”
That slightly garbles what depreciation is. Yes, it’s calculated as part of the cost, but it’s really how much the value has declined in a year.
The records reviewed by the New York Times did not expressly state how much Kushner paid in taxes, but included estimates for how much he owed called “income taxes payable” and how much Kushner paid in expectation of forecasted taxes known as “prepaid taxes”. The paper said that for most of the years covered, both were listed as zero, but in 2013 Kushner reported income taxes payable of $1.1m.
Kushner Companies, the family company for which Kushner was chief executive, has been profitable in recent years, the Times said, citing the analysis.
Well, that’s the thing, profitable before or after depreciation?
Over the past decade, Jared Kushner’s family company has spent billions of dollars buying real estate. His personal stock investments have soared. His net worth has quintupled to almost $324 million.
And yet, for several years running, Mr. Kushner — President Trump’s son-in-law and a senior White House adviser — appears to have paid almost no federal income taxes, according to confidential financial documents reviewed by The New York Times.
His low tax bills are the result of a common tax-minimizing maneuver that, year after year, generated millions of dollars in losses for Mr. Kushner, according to the documents. But the losses were only on paper — Mr. Kushner and his company did not appear to actually lose any money. The losses were driven by depreciation, a tax benefit that lets real estate investors deduct a portion of the cost of their buildings from their taxable income every year.
And that’s to entirely miss the point of what depreciation is.
In 2015, for example, Mr. Kushner took home $1.7 million in salary and investment gains. But those earnings were swamped by $8.3 million of losses, largely because of “significant depreciation” that Mr. Kushner and his company took on their real estate, according to the documents reviewed by The Times.
It’s reasonable, on those figures alone, to therefore state that Kushner made a $6.6 million loss that year. Which isn’t the sort of income we think would raise a significant tax bill really.
In theory, the depreciation provision is supposed to shield real estate developers from having their investments whittled away by wear and tear on their buildings.
In practice, though, the allowance often represents a lucrative giveaway to developers like Mr. Trump and Mr. Kushner.
Hmm, well, opinions are like fundaments. But that depreciation has to show up somewhere in that tax code. Otherwise we’ll not be taxing economic profits.
So, the background. You own a building, an apartment. This is a business and is taxed as one. Even if you’re not incorporated the tax code does agree that this is a business – assuming it’s rented to someone of course, or is available to do so. This doesn’t apply to the place you live in yourself.
So, there’s some income – the rent. There are also expenses on the place. We tax net income, not gross. In a business this means we tax profit, not revenue. So, getting the gas man around to fix the boiler, that’s a cost of the business of renting the apartment. If rent is $3,000 that month, the gas man bill $300, then the net income for the month is $2,700. That’s what might be subject to tax, not the $3,000. Pretty simple really. You get – usually – to deduct any interest you’re paying on the mortgage and so on. The end result is as we would wish it, that we’re taxing the net income, the profit, from the activity. And as far as possible we’re calculating the economic profit, not the mere accounting one.
So, as any landlord will tell you, as the tax code agrees, there are longer term expenses. The place will need a new roof every 25 years or half a century. A building might only have a reasonable life of half a century or a whole one. At some point you tear it down and start again. Or you stick the scaffolding up to entirely repoint the stonework. Or all the services – the aircon, heating, electrical wiring, water pipes – need to be ripped out and reinstalled.
That is, there are ongoing costs to keeping the building habitable. At some point we’ve got to recognise this in that tax code. If we don’t then we’ll be taxing people on profits they’re not making. One way to do this is to allow those costs in whatever year they’re incurred, then allow people to carry them forward. Say, every 20 years you’ve got to drop $40,000 sorting out the apartment and all the connected services. So, that year you’ve a $40,000 loss, which you can apply against those profits until it’s exhausted.
Another way is to say – and this is the UK tax code here – that there’s some amount that will even out over time. Say, oooh, 2%. Every 50 years you’ve got to spend the – roughly this is – purchase price of the building on sorting it out to keep it standing and habitable. So, we’ll let you deduct 2% of the value of the place every year – that’s 100% over 50 year. OK, ignoring net present value and all that but still. It’s a reasonable enough compromise. It does make that tax system easier to have the one known number and allowance.
Sure, we can argue about whether the number is right or not. But the basic principle is entirely solid. A building which doesn’t have maintenance done to it is indeed worth less than one that is maintained. And that bill is going to come due at some point too. Else the building will fall over – or people will refuse to live in it – either reducing the value to zero. Equally, we can argue about whether that depreciation should apply to the land value. No, it shouldn’t, but it might just because that’s what’s done.
So, to argue about specific rates is just fine. But to argue against the general principle is to be wrong.
We’ve also this interesting idea that Kushner hasn’t in fact been making a profit here. Assume that the depreciation allowance is in fact the amount that has to be spent upon that maintenance in order to preserve the capital value. Yes, yes, OK, maybe the allowance is too large and all that. But just for the sake of the logic, assume that the politicians have got something right for a change.
Thus we’ve got income of $1.7 million. Ignore that it’s salary, investment gains. Just treat it as income from real estate again for the sake of the logic. That depreciation allowance tells us that there’s also $8.3 million of depreciation. That’s maintenance that should be done but wasn’t, not yet. Or perhaps maintenance which will need to be done at some future point, those major works.
So, what’s the net effect here? Actually, Kushner has lost $6.6 million on real estate that year, hasn’t he? He’s consuming his capital, partly by not maintaining it, partly by taking capital value as income.
OK, that’s a slightly extreme way of reading it but there’s still a great deal of economic truth to the underlying logic of it.
And depreciation must, just must, be in the tax code at some point. For buildings do need maintenance and we really do want to tax only economic profit. Therefore maintenance is a cost to be deducted before taxable profits are calculated. A depreciation allowance being one of the ways of doing this. How else are we going to do it?
Finally, do note that if this were within a corporate structure this would be entirely uncontroversial. Sure, we deduct the replacement costs of Walmart’s refrigerators before we calculate their taxable profits. Much real estate investment is done through partnerships, meaning that the same just and righteous allowance often turns up on personal tax returns rather than corporate. And again, entirely possible to argue about the specifics of such allowances, the rates, but the general principle, well, depreciations and maintenance, the flip sides of the same coin, they’ve simply got to turn up somewhere. Otherwise we’d not be taxing profit, would we?