LC Posted August 7, 2018 Share Posted August 7, 2018 I'll repost the example here: It slipped by mostly in the shadows as just another story in the vast stream of bullshit from Trump's America's firehose, but the proposal to unilaterally change the way capital gains taxation works may be one of the most important stories, at least as far as it relates to Trump himself and the mind-boggling corruption he is probably going to get away with. In short, it may be the primary reason that he ran for President. If it ends up happening, the proposed change in the way we treat basis (by adjusting it for inflation, see proposed changes here) could cause a person who owns hundreds of millions of dollars of appreciated real estate, purchased before 1983, in a state with high income taxes, to go from being insolvent to being very much in the green. This profile sounds suspiciously like our dear President. I threw this hypothesis out here when Trump refused to divest his holdings, because it is a possible explanation for him being unable to liquidate his holdings. It's entirely possible that he has had his cabinet working on finding a way out of this hole his entire presidency, and they just now came across the ludicrous idea to change basis treatment as a solution. The problem for Trump: it's possible that for his real estate, in particular, he would be hit with a higher tax bill than any profit he would make (the tax bill + the debt repayment would be more than the sale price), and I doubt he actually has the liquid assets to pay the taxes. That's what happens when you get to "negative basis." He'd have to die holding those properties (or change the tax laws in his favor). **For anyone that actually cares to dig into the details, here's some free education on tax law!** **UNDER CURRENT LAW** (1) Taxpayer buys an office building in 1983 for $10,000,000 (assume for purposes of this example, the entire purchase price is properly allocated to the office building, which is depreciable). Over the next 30 years, the property appreciates in value, the taxpayer fully depreciates the original basis of $10 million in the building to zero, borrows against the property, and takes the loaned funds tax free. As a result in 2014, the office building is now worth $20 million, has zero adjusted tax basis, and has a mortgage on the building of $15 million ($5 million of net equity in the property). (2) Note, because the property was placed in service in 1983, an accelerated method of depreciation was allowable on the property. As such, a taxable sale of the property will be subject to recapture under the Code. Because the property was placed in service prior to 1986, recapture is under section 1245 (rather than section 1250, which generally applies to real property). As such, the total amount of the depreciation deductions is subject to recapture as ordinary income. (3) If the building is sold for $20 million in a taxable transaction, the gain would break down as follows: Amount Recognized: $20,000,000 Adjusted Basis: $ ------ Recapture: $10,000,000 ordinary income Long-Term Capital Gain: $10,000,000 long-term capital gain Assuming the taxpayer is in the highest income tax bracket and in a relatively high income tax state, like a New York City taxpayer, the ordinary rate would be approximately 45% and the long-term capital gain rate would be approximately 37%. The total tax liability would be $8.2 million. After repayment of the $15 million of debt, the taxpayer (who would net $5 million in cash from the transaction before taxes) would actually be in deficit by approximately -$3.2 million after the payment of income taxes. (4) Compare the result if the taxpayer died owning the building (assume for simplicity’s sake, the building no longer has a mortgage). The building would get a “step-up” in basis under section 1014(a) to fair market value, the recapture and long-term capital gain tax problem would be eliminated. If the taxpayer has $5.34 million of Applicable Exclusion available, the maximum estate tax liability (assuming a top state death tax rate of 16% and state death tax exemption equal to the federal exclusion amount) is approximately $7.3 million (maximum blended rate of 49.6%). If the Applicable Exclusion Amount grows to $8 million for example, then the estate tax liability falls to a bit less than $6.0 million. If the foregoing building was in California, the income tax liability would be greater, and the estate tax cost would be even less because California does not have a death tax. With an applicable Exclusion Amount of $5.34, the estate tax liability is less than $5.9 million.* (5) Property placed in service after 1986 will not have as egregious of an income tax problem because the gain would not have recapture calculated under section 1245. Rather, section 1250 would be the applicable recapture provision. “Section 1250 property” means any real property, with certain exceptions that are not applicable, that is or has been property of a character subject to the allowance for depreciation. Section 1250(a)(1)(A) provides that if section 1250 property is disposed of, the "applicable percentage” of the lower of the “additional depreciation” in respect of the property or the gain realized with respect to the disposition of the property shall be treated as ordinary income. In short, section 1250 provides that all or part of any depreciation deduction in excess of straight-line depreciation is recaptured as ordinary income. Under the current depreciation system, straight-line depreciation is required for all residential rental and nonresidential real property. As such, section 1250 recapture is typically not a problem for property placed in service after 1986. The Code does, however, tax “unrecaptured section 1250 gain” at a 25% tax rate. Unrecaptured section 1250 gain is essentially the lesser of all depreciation on the property or the net gain realized (after certain losses) to the extent not treated as ordinary income under section 1250. **UNDER PROPOSED CHANGES TO BASIS** Chain the purchase price of the building in my above example to inflation. $10 million in 1983 is a little over $25 million in 2018 ($25,300,100.40). We'll keep the numbers simple and round it to $25 million. For the purpose of this example we're going to assume that the proposed changes to basis adjustment chain the original purchase price to inflation, and not the adjusted numbers along the way, as record-keeping for that sort of thing would prove nearly impossible. Thus, Taxpayer buys building in 1983 for $10 million. He fully depreciates it under existing tax laws, saving money on his income taxes, over some indeterminate period of time during the next 34 years. The building appreciates to $20 million, and he borrows against the new equity, tax free. Let's use the same numbers as above. At the end of the term, the building is worth $20 million, there is an existing mortgage of $15 million, and the net equity is $5 million. Taxpayer has benefited from the use of the tax savings through depreciation and the use of the tax-free money he got by re-mortgaging the property after its appreciation. PLOT TWIST, the Trump administration decides, unilaterally, that the $10 million purchase price should actually have been indexed to inflation, so the purchase price is now set at $25 million. After you deduct the correctly taken $10 million in depreciation, that leaves an adjusted basis of $15 million. With the new adjusted basis, Taxpayer can completely wipe out the $10 million of recapture liability, as well as half of the long-term capital gain liability, leaving him a tax liability of only $1.85 million. Given that the taxpayer pockets $5 million in cash from the proceeds of the transaction after paying off the debt on the property, he has $3.15 million left after paying off the long-term capital gain. **Summary** Under the proposed changes to basis, a Taxpayer that suspiciously fits the profile of Donald J. Trump goes, overnight, from having a $3.2 million LOSS on a sale of property to a $3.15 million GAIN on the same property, under the same set of facts. This taxpayer has also already received the benefit of ~$5 million in reduced taxes through depreciation deductions along the way, as well as the use of tax free funds from new debt on the appreciated property. Now realize that the numbers in the example are peanuts compared to the hundreds of millions in purchases Donald Trump's company made over the years and the massive appreciation in NY real estate. *The exclusion amount is based on 2014 numbers and ultimately doesn't matter, but the exclusion amount is now $11.18 million per person in 2018. Way to go, America. Quote Link to comment Share on other sites More sharing options...
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