The Release of Trump’s $1 Billion Loss Is A Red Herring

In a seemingly cathartic revelation, the “leak” of Trump’s nearly $1 billion loss on his 1995 tax forms purports to explain how and why Trump could be paying zero in taxes.

But it’s too neat — and I think it’s intended to hide something else. Here’s why I think so.

First, the fact that Trump is using a carry-forward deduction to avoid taxes just isn’t that controversial or even “wrong.” To understand why, a quick explainer on capital gains:

A capital gain (or loss) is money you make, roughly speaking, by shuffling paper. It differs from wage income, which is what you make when you work at Burger King. It’s also taxed differently. One of those differences is that you can deduct (subtract) capital losses from capital gains when you’re calculating your taxes.

For example, if you make $100 trading stocks and lose $80 trading other stocks, you can deduct the $80 loss from the $100 you made, and you’ll only get taxed on the remaining $20. If you lose $100, then you can deduct $100 from $100 for a gain of zero — and thus pay zero taxes. And of course, if you lose $200 and only gained $100, then you’re actually $100 in the hole, and you definitely don’t owe any taxes.

Further, if you lose $200 trading stocks, and then make $100 later in the year, and then make $100 trading the next year, you can “carry-forward” the loss from the original $200 you lost: First, you apply $100 of your loss to cancel out the loss from the first year. If there’s any left over, you’re able to use it the next year to cancel out loses you incurred that year (that’s the “carry-forward”). You can do this until you’ve “used up” all of the loss canceling out your gains.

That’s actually reasonable because eliminating your ability to deduct a loss shouldn’t depend on the exact timing of those losses: if you lose the $100 on December 29th, and then a few days later (in the next year) you make $100 on Jan 3rd, it’s still reasonable that you should be able to deduct that loss. The ultimate reason is because in the end, you didn’t make any money. You lose $100 and make $100, and you’re zero dollars ahead, so it wouldn’t be fair to tax you (you also wouldn’t be able to pay).

So that’s how capital gains and losses are deducted against one another.

Trump’s tax record “leak” is an extreme example of this: he lost nearly a billion dollars, and this implies that (supposedly) over the next few years he made that money back and doesn’t owe any taxes on it because he’s still applying that carry-forward loss on the subsequent years.

And thus, what’s the problem — he’s just a Big Man operating on Big Numbers — right?

It’s A Decoy To Get You To Stop Looking Too Hard

The fact that he’s using a carry-forward loss is too neat of an explanation… because it’s not really that scandalous. It’s just scandalous enough to satisfy the news cycle, but not answer any real questions.

It makes it look like all he did was an extremely large version of the same thing that pretty much any middle-class American who’s made or lost money on the stock market also does. In the end it’s not that scandalous… and that’s the point, because it “resolves” the tax question too neatly. After all, if you lose $1 billion and then make $1 billion, you don’t come out ahead.

Consider: Trump today claims he’s worth upwards of $10 billion. The most conservative and dubious estimates put him at least at $3 billion. Even if Trump used the entire carry-forward amount of that $1 billion loss in 1995, he still needs to account for anywhere between $2 to $8 billion on which he should supposedly owe taxes… right?

Well, maybe he had all that money before that loss. Maybe he had $9 billion and only lost $1 billion of it, and today he has $10 billion, so he just spent the last 20 years making back that $1 billion (now tax-free) that he lost. That’s obviously unlikely. The early 90s are the time when Trump famously made his comments about “That bum isn’t worth a dime, but at least he’s at zero. That puts him $900 million ahead of me.” So in 1991 his net worth was negative $900 million.

This incredibly well-timed “leak” of Trump’s 1995 tax returns is intended to defuse the “does he pay zero taxes” furor by making it look like he’s only deducting from a large carry-forward loss, but a cursory examination indicates that this sticker-shockingly YUUUGE number intended to divert your attention cannot possibly be enough to account for him not paying any taxes.

Which means if he’s still paying zero in taxes today, he’s doing some other stuff that he doesn’t want you to know about — and it probably looks worse than “he lost a billion dollars in 1995.”

What Else is Trump Doing To Avoid Taxes?

First, it’s almost certain that he’s not evading taxes. Tax evasion and tax avoidance are two different things: tax evasion is not paying your taxes by breaking the law. Tax avoidance is using legal means to minimize or eliminate your tax bill. Trump is currently being audited by the IRS (that by itself is not necessarily a sign of wrongdoing — rich people get audited a lot), and claims he is constantly being audited. If he was engaging in actual tax evasion, he would very likely be caught — the IRS is very thorough when they want to be.

Second, what he’s probably actually doing is what financial experts have hypothesized for some time now: using a special section of the tax code designed for real estate investors to avoid paying any taxes.

In Real Estate, You Can Defer Taxes Indefinitely

There is a thing in the tax code called the “1031 Exchange.” Essentially, it means that if you carefully follow a set of rules when selling a piece of real estate and buying another one, you can avoid paying taxes on that sale entirely.

Capital gains on the sale of this property are deferred or postponed as long as the IRS rules are meticulously followed. This is a wise tax and investment strategy as well as an estate planning tool. In theory, an investor could continue deferring capital gains on investment property until death, potentially avoiding them all together. [1]

For a career real estate investor, Trump can therefore build up a real estate property, then liquidate it, and as long as he rolls the proceeds into another property within 45 days, he doesn’t pay any taxes on that sale. Since he has a lot of projects going on all the time, he can easily find another property to reinvest the proceeds into, and can therefore do this indefinitely.

Further, in real estate there is a concept called “depreciation,” which allows you to (in layman’s terms) gradually take the amount that you paid for the property and claim it as an expense against your rental income. Since you already paid for the property, this isn’t real cash that came out of your pocket, while the rental income is real cash. This means that while your tenants are paying you rental income, you can deduct “imaginary” money (depreciation) from it and put that cash in your pocket tax-free.

Normally, the depreciation used in this manner is “recaptured” in a special tax when the property is sold — so normally, things would even out. However, a real estate investor can use the 1031 exchange to defer this tax.

He can then combine these two methods: use depreciation to create paper losses that offset other gains (thus producing cash), and then avoiding the recapture of this depreciation when the asset is sold by engaging in a 1031 Exchange, thus generating cash on an ongoing basis while deferring taxes on any of it until he dies.

That’s how Donald Trump can pay zero taxes, while still making tons of cash to afford those private planes, fancy suits, and KFC dinners.

Why Doesn’t He Wants Us To Know About This?

If Trump released his full tax returns, we’d see him and his businesses making repeated use of this method to avoid paying taxes indefinitely.

This method is available to all real estate investors. When I showed a draft of this piece to a friend who has been building hotels, he agreed, saying “the basic formula is: defer income taxes to capital gains via depreciation, then defer capital gains via 1031 exchange. 1031 exchanges are pretty ridiculous, whatever the initial logic behind them. They are a gigantic loophole that gives real estate investments unnecessary special treatment vis a vis other asset classes.”

The reason Donald Trump doesn’t want us to see this is not because we might get mad at him or even that it might cause him to lose the election. It’s because if the front page of every newspaper publicized this tax loophole (well-known even to rookie real estate developers), there would surely be enormous public pressure on Congress to close it.

Since it advantages real estate over other asset classes, Trump wouldn’t even have the support of other wealthy 1%-ers: Mitt Romney himself was famous for paying “only” a 14% tax rate, because his profits from private equity were still taxed at capital gains and dividend rates. Having this loophole closed would cost Trump potentially billions of dollars in future profits, and that’s worth way more to him than an election.

That’s why he’d rather you know that he lost a billion dollars 20 years ago and used it to avoid taxes on his next billion, rather than tell you about the trick he uses to avoid taxes on his many subsequent billions today.

Well, Good Luck, America!

I’ll see you at the polls on November 8th.