In Search of the Perfect Investment

The IRS looks most favorably on investing in real estate.

Vanity Fair just wrote on The Great Trump Tax Mysteries. Excerpts:

There are a few big tax strategies in real estate, underpinning some of America’s greatest fortunes.

First, there’s depreciation. Cars, say, lose value, and it makes sense to set those real losses against tax. Buildings, though, generally appreciate in value-yet such is the power of the real-estate lobby that you still get the depreciation deduction, which is based on a formula.

Strategy number two: In theory you pay taxes on your gains when you sell up-but you can get out of that too by using another officially approved scheme, known as the “like-kind exchange.” Here, if you re-invest the proceeds of a sale into a qualifying real-estate project within 180 days, you can postpone paying the tax. The I.R.S. has interpreted this rule very broadly, says Ed Kleinbard, professor of law and business at the University of Southern California’s Gould School of Law and author of We Are Better than This, a book on the U.S. fiscal system. “So a swap of farmland for an office tower is viewed as a like-kind exchange. The trick in real estate is to keep all the balls in the air as best you can, until you die.”

As if that weren’t enough cream for the real-estate moguls, the sector is fueled by borrowing-and you can set the interest expenses against your income. Lenders will often give mortgages for 90 percent or more of a project’s value, meaning that very little of a developer’s money is involved. Interest and depreciation usually wash out the rental income. As Trump himself once put it, “Leverage: don’t make deals without it.”

… And this brings us to yet another avenue to tax-free living for real-estate moguls. These deductions can travel. If you are an active real-estate professional-that is, in part, if you spend at least half of your work time in real-estate activities-then you’re allowed to assemble all your losses and deductions, magpie-like, wherever and however you suffered them, whether it’s from Trump Tower or a Scottish golf course, and throw them all into one big pot. (When Trump was asked whether he was active in real estate, for tax purposes, he responded: “I don’t know how I am categorized, but I spend a lot of time on real estate . even during the campaign.”) You then stir in your federal income and hope those losses will offset it all, like one of those science experiments where you pour one liquid into another, brightly colored liquid to make it all go clear. With enough deductions, a real-estate mogul like Trump can zero out his federal income-tax bill.

If Trump is not considered active enough in real estate, however, he is covered by a different system, for investors, and those real-estate losses do not travel, says Lee Sheppard, a tax lawyer and widely read contributing editor at the trade publication Tax Notes. Trump told me he won’t release his tax returns yet because he’s under a “routine audit,” and Sheppard speculates that the audit could be about this very question: whether he is active enough in real estate to be able to use those real-estate losses to offset other income-something that would become a lot harder to argue, Buckley adds, if he were president.

Even if Trump can’t get to zero after taking advantage of all this, he need not fear: he may be able to deduct expenses incurred by his celebrity lifestyle. Sheppard explains this by citing comedian Carol Burnett, who starred in her own variety show on CBS, starting in 1967. “This really was the 60s,” says Sheppard. “When you came out on the stage you wore a sparkly evening gown.” In those days celebrities paid for their clothes, and Burnett wanted to take the gowns as business expenses. The I.R.S. fought her, but she argued successfully that she would not wear them to the grocery store: they were specific work garments. “Entertainers fight about this stuff with the I.R.S. all the time,” Sheppard says.

We can’t see such deductions without Trump’s tax returns, but we can see other things Trump has put into this pot. A Wall Street Journal analysis, for instance, shows that he was able to deduct $39.1 million from his 2005 federal income tax via a “conservation easement,” which meant he simply pledged not to build houses on a golf course in Bedminster, New Jersey, thus reducing the land’s value. Trump’s charitable deduction for the easement amounted to an estimated 2 percent of the entire U.S. total of conservation easements that year, and Trump has done it on at least four of his properties: Mar-a-Lago, in Palm Beach; his Seven Springs estate, in Westchester County, New York; Bedminster; and a golf driving range in California. When asked if he would curb tax privileges for real-estate moguls, if elected president, Trump said, “I’m not doing anything further with this.”

If Trump hasn’t yet gotten to zero, there’s still another tantalizing possibility: offshore tax havens. Sheppard thinks he doesn’t need to bother because “real estate in the U.S. is so juicy you don’t need tax havens.” Trump himself says, “I don’t use them. Honestly I think it’s more trouble than it’s worth: highly overrated,” he says. “They don’t work, and they cause lots of difficulty, and nobody knows what’s going on, and they are really not good.. There is greater incentive in many ways to keep your money in the U.S.”

But it isn’t strictly true that Trump doesn’t use them. He disclosed a company, DJ Aerospace Limited, which he set up in the tax haven of Bermuda in 1994. (Trump declined to respond to questions regarding this company and a handful of other questions as well.) And he also reportedly transferred more than 110 registered or pending trademarks to a holding company in Delaware, which many people view as a tax haven inside the U.S. because it is secretive and can help you avoid taxes in other states.

Other Trump tax-haven activity is harder to find, yet Kleinbard says you can’t rule it out, as when royalties are paid for the use of Trump trademarks for foreign projects he does own. (That Trump has refused to release his returns positively invites such speculation.)

Many big businesses park foreign income in tax havens, to defer or escape tax: Apple alone holds an estimated $180 billion or more offshore. Could Donald Trump be doing the same? His brand names and trademarks are intangible assets separate from the man himself, and therefore are similar to the intangibles that drive the profits of U.S. tech firms. Could the non-U.S. rights to Trump’s very name be owned by an offshore tax-haven company? If so, as Kleinbard explained to me, the royalties might flow from a Donaldco in Delaware to a company higher up the corporate “tree” in the Netherlands, then further up to an Irish corporation resident in Bermuda (don’t ask), where they would ultimately be parked offshore as “stateless income,” incurring no tax. This might be Romney’s “bombshell.” (Romney should know. After all, he was found to be parking secret stuff in Bermuda.)

To read the rest of the long Vanity Fair article, click here.

Useful stuff

+ Unsubscribing with real companies works. They will, most likely, get you off their emailing list, sand save your groaning inbox

+ Please don’t get ramrodded into “upgrading” to Windows 10. Microsoft is telling the world that “free” upgrades will expire soon. Remember the old adage: What you paid is what it’s worth. A new machine with a brand new Windows 10 may make sense — but you still have to add in all the software you use. Pray you find the original discs and pray that your old software works with the new Windows 10 — which it often doesn’t. I’m a firm believer in “If it works, don’t fu*k with it.” Which is is why I’m sticking with Windows 7.

+ “When you’re trying to choose a vocation, pick the four happiest moments in your life. See if they line up in any direction, and that way you figure out what you love.” – David Brooks, Op-Ed columnist, The New York Times, on choosing a profession.

I’m guessing their “Congress” isn’t gridlocked. From the Economist:

 To give more students access to higher education, the government has increased its investment in the sector fivefold since 1997. The number of universities has nearly doubled. In 1998 46% of secondary-school graduates went on to university. Now 88% of them do. About 7 million people — roughly one-third of those aged between 18 and 22 — now gain entry to some form of higher institution each year.

The boom in health spending

Average health spending will surpass $10,000 a person in 2016, after years of slow growth, the Obama administration has said, and health care is expected to account for 20 percent of the economy by 2025.

Big pharma — like Merck and Bristol Meyer — seem to be among the easier ways to play this.

What is it?

A friend who likes animals sent us this photo. I asked the family if they knew what it was?

My daughter Claire, who is an excellent ornithologist, answered correctly, “It’s a small mammal with excellent hearing. Those fingernails really do need some attention.”

Great puns

 + Venison for dinner again? Oh deer!

 + A cartoonist was found dead in his home. Details are sketchy.

 + England has no kidney bank, but it does have a Liverpool.

 + I tried to catch some fog, but I mist.

 + I changed my iPod’s name to Titanic. It’s syncing now.

 + Jokes about German sausage are the wurst.

 + I’m reading a book about anti-gravity. I just can’t put it down.

 + I  didn’t like my beard at first. Then it grew on me.

 + Broken pencils are pointless.

 + I dropped out of communism class because of lousy Marx.

 + Velcro – what a rip off!

And my favorite:

 + All the toilets in New York’s police stations have been stolen. The police have nothing to go on.

Harry Newton, who slept well last night after yesterday’s colonoscopy but this morning really feels the aches and pain of missing exercise for one day. In case you missed last night’s blog recommendation on Central Garden and Pet Co (CENT), click here. The blog was called Product Extension.

A reader who understands options emailed me:

I sold some Oct 17.5 puts on CENT in June, which are now well in the money.

Selling puts on stocks going up is a good strategy.

I asked him for more explanation. Here’s his reply:

Here goes. I do most of the trading in my IRA, therefore my online broker requires that I have the cash to buy the stock if I’m PUT the stock at the strike price on the expiration date.  This is called a Cash Secured Put.  One can also sell naked Puts using margin.

Selling puts is Warren Buffett’s favorite option strategy and mine too. He uses it as a way to acquire stocks at a guaranteed price by selling a put (insuring a stock) at a price he would be comfortable buying the stock at anyway (in case it gets “put” to him) and creates extra income to boot.

Case in point. In 1993 Buffett wanted to purchase five million shares of Coca-Cola at $35 a share. It was trading at $39 then. He sold 50,000 put contracts and insured the stock for $35 ($4 below the current price) and collected $7.5 million in upfront cash premiums.

If the stock dropped to $35 or lower he would be assigned the stock. All that means is he would have to buy shares in Coca-Cola at $35 per share, which he wanted to do anyway. Either way he got to keep the $7.5 million in cash so it was a win-win for him.

By selling put options, rather than buying the stock outright, he not only guaranteed the price he paid for Coca-Cola($35), he got paid extra income to boot.

He did the same thing in 2008 for his investment in the railway company, Burlington Northern Santa Fe. He sold nearly 5.5 million put options to establish a stake in the company before he purchased the entire company and took it private.

That same year he also sold put options on various stock indices around the world and generated up front premiums of $4.9 billion that he then used to buy other cash-gushing companies at deep discounts.

Therefore, if CENT is below $17.5 in Oct, I buy it and sell CALLS.  If not, I keep the premium I collected in June. Got it?