Trump Says ‘He’s Smart’ for Not Paying Federal Taxes. It’s also Probably Legal

During last night’s debate at Hofstra University, Hillary Clinton hit Donald Trump hard on his refusal to release his tax returns. Trump has long held that he won’t because he is currently under audit, and his lawyers have advised against it. However, a particularly revealing exchange happened when Clinton accused Trump of not paying federal income taxes. Trump interjected, “That makes me smart.”  Trump clarified his statement a bit (see tweets below), but he hasn’t exactly walked it back.  And, yes, even with hundreds of millions in revenue from Trump’s real estate empire, it is entirely possible and also perfectly legal that he doesn’t pay federal income tax — or pays very little. We’ll explain why.

Since, we haven’t seen his current tax returns, we don’t know for sure whether or not he’s currently paying federal income taxes.  However, the last time information was made public from his tax returns in the 1970s, they showed he paid zero income tax for several years. “The disclosure, in a 1981 report by New Jersey gambling regulators, revealed that the wealthy Manhattan investor had for at least two years in the late 1970s taken advantage of a tax-code provision popular with developers that allowed him to report negative income,” The Washington Post reported.

While it might sound illegal, the truth is many people in the real estate industry take advantage of these loopholes. And it’s perfectly legal to do so.

“Given what he does it could be that Mr. Trump is able to write off a great deal of what others might consider personal living expenses as business expenses, offsetting his income,” Lester Weingarten, an accountant who handles high net worth individuals, told,  “The losses are most likely legitimate, however the optics are not good.  Hence he is not going to release the returns.  Audits have nothing to do with this; the optics are just not good.”  If you want a full explanation of how Trump might have skirted the income tax, Weingarten explains much more in our email conversation, and we’ve pasted it below.

“Real estate is notorious for throwing off huge deductions,” Steven M. Rosenthal, a tax lawyer and senior fellow at the Urban-Brookings Tax Policy center, told The New York Times. “That coupled with wide latitude in the timing and recognition of income make real estate development extremely attractive from a tax standpoint.” So like it or not, Trump is not doing anything illegal (if he is indeed skirting the federal income tax.)  If you have a problem with it, you may want to contact your local Congressman, because Trump is doing what many savvy investors do everyday. They try to hold on to their money.

More from tax accountant Lester Weingarten on Trump not paying taxes:

He is in real estate.  Buildings are bought on borrowed money.  The cost of such buildings (not including amounts allocated to land) are depreciated over a number of years (residential over 27.5; commercial over 39).  This creates a deduction, but little cash is actually expended if most of the purchase price of the property and for improvements are through borrowed funds.  If the owner does cost segregation, the depreciable life is reduced creating even faster write offs.  A part of the assets might qualify for bonus depreciation which is even faster write offs.  It is possible between rental income less the costs of running the building, interest expense on the mortgage and depreciation, there could be a loss, but on an economic basis there could be sufficient cash flow to provide funds.  It is the combo of using borrowed funds and getting the depreciation that could create a loss for tax purposes, yet the building could provide cash flow to the owner.  Real estate is generally considered a passive activity where one cannot take a current loss (it gets carried forward to the future when or if the property has a taxable profit or is sold), however Mr. Trump most likely qualifies as a real estate professional, so he is entitled to the loss as the passive activity rules would not apply to him.  The losses on his various real estate activities could more than offset income earned in other areas (i.e. salaries, other earned income, investment income such as interest dividends and capital gains).

More from tax attorney Robert Kovacev from Steptoe & Johnson:

Bottom line is, Mr. Trump is basically (from a tax perspective) a large business enterprise and can take advantage of tax breaks available to big businesses that you and I can’t. One example is depreciation deductions on real estate. Due to special carve outs in the tax code he could take depreciation deductions for real estate even while the real estate is appreciating in value, and not have to recapture those deductions until he sells-and sometimes not even then. Also, interest on loans for business purposes is deductible. Further, if he suffered losses from any of his business ventures in past years, those losses can offset income for up to 20 years later. In other words, if he has net operating losses from the late 1990s, he could still potentially be using it to offset today’s income and pay no tax. There are also lots of tax credits for business activities (like investments in renewable energy) he could potentially invest in that would lower his tax rate.

Finally, if he has assets that appreciate in value, he doesn’t have to pay any tax on that appreciation until he sells it (if he does), but he could use the asset as collateral for a loan or line of credit, so he gets the benefit of the appreciation without having to pay tax (and potentially deducting the interest). It’s like a home equity line of credit, only with more zeroes.

To be clear, I don’t know whether Mr. Trump actually used any of these strategies. further, if Mr. Trump is following the tax code, there is nothing wrong with him having a very low or zero tax rate. The law says that taxpayers must pay their correct amount of tax liability, but not more than that.

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