Trump and Depreciation

With the latest information about the tax schemes of Donnie Two-Scoops hitting the interwebs this week, there's talk about depreciation...and most of it is inaccurate. News reports paint depreciation as some giant scam which allows the rich to avoid paying taxes. What it is, is a way to spread the expense of a major purchase over the life of that purchase.

The first thing to understand is that, for a business, your taxable income is your gross, or total, revenue minus your expenses. If you sell $100,000 of product, but your labor costs, equipment maintenance, supplies, rent etc comes to $55,000, then your taxable income is $45,000. That is, you pay taxes on $45,000, not $100,000. If your revenue was only $40,000 (maybe your store suffered tornado damage) but expenses were still $55,000 then you had a net loss of $15,000 and would pay no taxes.

If a developer buys a building for $390,000, that's an expense. But it's a particular kind of expense. It's the purchase of an asset that does not get used up right away, like office supplies, or sold, like inventory. If this developer had $100,000 in revenue and subtracted the $390,000 he would have a loss of $290,000. But the IRS allows the developer to spread out the expense over the projected life of the building, in the case of commercial property, 39 years (other types of assets have shorter projected useful lives). So, assuming that gross revenue is still $100,000, the depreciation expense would be $10,000 every year, giving the developer a net income of $90,000 before taking into account any other expenditures. Either way the developer spent the money, making it a legitimate expense to be deducted from gross revenue, the only difference is when the expense is deducted.

Now this becomes a cash flow advantage to the developer since he probably didn't spend his own money on the building, but took out a loan that would take 5-20 years to pay off. This also allows the net income reported to investors to be somewhat consistent, rather than extremes of profit or loss that might occur when making very large asset purchases.

Trump has been pointing out that net losses due to depreciation are normal. But the thing is, eventually you have to get to the point where your revenue exceeds your expenses. The depreciation expense may not be a cash expense, that is, it doesn't reduce the amount of cash on hand in the year that you take it, but at some point you spent that money and need to earn enough revenue to pay for it. You either spent it in one lump sum upon purchase (unlikely) or you're paying every month in principal and interest payments.

[We've been talking about the effect of depreciation on income tax, the effect on property tax is different and is outside the scope of this discussion]

An analysis that I saw last night suggested that the reported losses were much higher than could be explained solely by depreciation. The story, in my opinion, is not that Trump legitimately claimed depreciation expenses to offset his income but whether:

1.  His other expenses were legitimate
2. The valuations that he put on his buildings was legitimate (mainly for property tax)
3. These losses indicate incompetence at business
4. He is just a self-promoting blowhard

The fact that he claimed losses does not alone prove any wrongdoing, if he legally and legitimately claimed expenses that reduced his taxable income, then he is, as he said in the debates, smart (or at least his accountants are). What this does show, in my view, is that Trump was not the business guru that he claimed to be, and what he has always been good at is making sure that he got paid even when businesses failed, and convincing people that he is a business guru.