How the Very Rich Legally Avoid Paying Taxes

Taxes

It is not that difficult–if you have access to capital. Here are the steps:

(1) Buy an apartment complex for $10,000,000 at a 4.5 percent cap rate with a 35 percent downpayment; finance $6,500,000 with an interest only loan at 3.5 percent that comes due in five years.

(2) Let’s say 35 percent of the value of the property is land and the remainder is improvements. Improvements on apartments are depreciated on a straight line basis over 27.5 years. So taxable income is 450,000-227,500 (interest) – 236,363 = -13,863 or a taxable loss.

Meanwhile, cash flow is 222,500 per year. So one gets cash while taking a tax loss.

(3) It gets better. Suppose when refinancing happens in five years, the property has gained 20 percent in value. Now one gets a 65 percent LTV loan on a $12,000,000 property–and gets to pull $1,300,000 out of the property. Suppose NOI has also gone up 20 percent. Sow now taxable income is 540,000-273,000-236,363 = 30,636.

Assume that the owner’s all in marginal tax rate is 50 percent. In exchange for a one time $1,300,000 in cash and cash flow of $267,000, the owner pays a little over $15,000 in taxes and 3.5 percent in interest on the extra money. No matter how one looks at it, this is a tax rate on cash of less than 10 percent.

It keeps going for 27.5 years, at which point the owner can defer taxes via a like-kind exchange. All of this is perfectly legal. And it explains why salaried workers pay more in taxes than owners of capital.

About Richard K. Green 103 Articles

Affiliation: University of Southern California

Richard K. Green, Ph.D., is the Director of the USC Lusk Center for Real Estate. He holds the Lusk Chair in Real Estate and is Professor in the School of Policy, Planning, and Development and the Marshall School of Business at the University of Southern California.

Prior to joining the USC faculty, Dr. Green spent four years as the Oliver T. Carr, Jr., Chair of Real Estate Finance at The George Washington University School of Business. He was Director of the Center for Washington Area Studies and the Center for Real Estate and Urban Studies at that institution. Dr. Green also taught real estate finance and economics courses for 12 years at the University of Wisconsin-Madison, where he was Wangard Faculty Scholar and Chair of Real Estate and Urban Land Economics. He also has been principal economist and director of financial strategy and policy analysis at Freddie Mac.

His research addresses housing markets, housing policy, tax policy, transportation, mortgage finance and urban growth. He is a member of two academic journal editorial boards, and a reviewer for several others.

His work is published in a number of journals including the American Economic Review, Journal of Economic Perspectives, Journal of Real Estate Finance and Economics, Journal of Urban Economics, Land Economics, Regional Science and Urban Economics, Real Estate Economics, Housing Policy Debate, Journal of Housing Economics, and Urban Studies.

His book with Stephen Malpezzi, A Primer on U.S. Housing Markets and Housing Policy, is used at universities throughout the country. His work has been cited or he has been quoted in the New York Times, The Wall Street Journal, The Washington Post, the Christian Science Monitor, the Los Angeles Times, Newsweek and the Economist, as well as other outlets.

Dr. Green earned his Ph.D. and M.S. in economics from the University of Wisconsin-Madison. He earned his A.B. in economics from Harvard University.

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