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Tax Avoidance Real Estate


Discussion             Presently, there is an unresolved dispute regarding real estate billionaires who pay lower income rates than their employees. At the same time, they give advice on the...Read More


~Posted on Mar 2018

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Discussion

            Presently, there is an unresolved dispute regarding real estate billionaires who pay lower income rates than their employees. At the same time, they give advice on the amount of income tax that other people should pay (Hannon, 2015). The dispute lies in the inadequacies of the prevailing codes that allow the wealthy to accumulate vast properties yet they pay little or no tax. A point worth noting is that most of the tax avoidance scams are perfectly legal. In recent years, there have been claims that financial experts have come up with numerous theories that allow real estate tycoons to accumulate property without meeting their tax obligations. Unfortunately, middle-income earners continue to pay high income taxes, despite earning much less. In effect, there is a perception in the United States that the rich avoid paying taxes, while the relatively poor pay through the teeth. The current taxation system is, thus, unfair. Ideally, those who earn more should pay higher taxes than those who earn less. However, real estate investors in the United States continue to evade the taxman, as middle-income earners drive the economy with their taxes. Therefore, there is a need to level the playing field and distribute the tax burden equitably to ensure that the government gets the revenues it requires to meet its obligations without oppressing any section of the society, while favoring the other.

            There have been claims that tax avoidance is beneficial to both individuals and firms alike. One of the prominent concepts is “No Income Means No Tax,” which means that the biggest income tax loophole is the definition of an individual’s income (Petrova &Ling, 2008). The majority of the people assume that their income is their salary and bonuses. However, the wealthy perceive salary as trivial if at all they receive any, because their riches come from the appreciation of their real estate investments among other assets. It is worth noting that the wealth of real estate magnets increases by hundreds of millions annually. Unfortunately, tax codes do not define this appreciation is as income. Therefore, it is not subject to income tax (Trumny, 2016). Further, the taxes due from real estate income are effectively taxed lower than those on salaries and bonuses. In addition, increases in the value of shares in the real estate sector are not liable to taxation, unless one sells them. If they remain unsold, the owners do not account for them. This is advantageous to real estate investors, since no matter how much their wealth increases on paper, they do not have to pay the government a penny until they seal a sale.

In essence, the prevailing tax system in the United States does not impose taxes on wealth. Typically, real estate investors receive small salaries relative to their total compensation for their shares. The ownership share is the carried interest. Notably, it receives a preferential treatment as capital gain instead of income tax. When real estate investors’ tax bill is due, they owe the federal government twenty 20% of the long-term capital gains tax rates, rather than the 39.6% tax applicable to ordinary income (Hannon, 2015). A clear example is the loophole that Mitt Romney exploited when filing his tax returns based on capital gains during his tenure at Bain Capital.

Unfortunately, Congress’ efforts to find a solution to this issue have been futile, because of lobbyists who are unwilling to pay more tax. Recently, Donald Trump, a U.S. presidential candidate, refused to release his tax returns. He claimed that he could not comply since he is under an Internal Revenue Service (IRS) audit. Trump’s empire sits on a racket with loopholes, several tax breaks, and deferrals that tend to make the real estate developers extremely rich by eliminating most of their tax obligations. Trump plays a tricky, two-step strategy to evade taxes. For example, he claims in his Financial Disclosure Report that he made around 10.3 million dollars from his property (Trumny, 2016). However, when it was time to pay property taxes, he argued that his property was worth USD1.36M. Besides, he won big because of charitable tax deductions that allow the property owners to impose permanent conservation measures. These tax evasion strategies are common among real estate moguls who can afford the services of tax lawyers. Therefore, they exploit the available tax breaks, thus, protecting their wealth.

The Real Investment Trust was formed with the objective of holding properties by providing the investors with the opportunity of investing in real properties. However, by providing waivers on the corporate level income tax on REITS to make the scheme more attractive the congress created a tax avoidance loophole. This is because the liquidation of the real estate assets was difficult and one was entitled to paying estate tax before the sale of the property (Yinger, Bloom& Boersch-Supan, 2016).

According to Yinger et al., the income from equity and debt investments receive preferential treatment, for instance, there are discrepancies in the classification of income from cash flow during the hold and sale period which impacts the rate at which the investors pay taxes (2016).Also, the income tax is considered an ordinary tax while the interest and ordinary income are taxed at a rate similar to the taxpayer's marginal rate. The capital gains from the net profits upon sale also get taxed at the taxpayer's marginal rate. Besides, there are tax consequences arising from state’s regulations and tax requirements and the investors are required to file in the state they have invested as long as there is a state income tax.

Solutions and Evaluation

            Tax experts have proposed several ideas that could help correct the issue of tax avoidance in real estate and, hence, increase federal revenues. Some of these strategies include adjusting real estate depreciation schedules to match the economic conditions and limiting the percentage of the property financed with the developer’s own equity (Armstrong, Blouin, Jagolinzer & Larcker, 2015). This would mean that only the manufacturers would have the permission to deduct the expense of capital equipment in the year of purchase. The reform from the multi-year depreciation deductions to the first year expensing would help spur economic growth for every dollar of revenue lost, because it would remove the current tax code bias. Consequently, it could increase productivity and create jobs for Americans. Besides, a reduction of the incentive to donate to charity to avoid taxation could result in a drop in the number of itemizers, hence, increasing tax revenues in the country. It is worth noting that real estate investors would continue to itemize and benefit from tax deductions. However, their subsidy would be much lower than it presently is, because of the significant reduction in tax rates.

            The above-mentioned solution to tax avoidance in the real estate sector is pragmatic. However, tax experts and economists argue that the reforms should include additional legislation action to prevent tax evasion (Armstrong et al., 2015). Therefore, there is no consensus yet on the way forward on an issue that have left many poor Americans feeling conned by their government. In the meantime, wealthy real estate owners continue to enjoy their riches, as the debate on the topic ranges on with no solution in sight. Clearly, tracking real estate transactions and sharing the tax residency information to enable the IRS to cross-reference individual tax records and identify those avoiding paying the proper fees is a viable solution to the problem. Indeed, it could force real estate moguls to comply with tax regulations, since they know that all their details are under IRS scrutiny. Besides, reporting every real estate transaction directly to the IRS would ensure that there are no illusions of getting away with the sale of the property, because of the continuing crackdown. However, such reforms might not be effective without the necessary legislation. Therefore, Congress must go beyond self-interest and pass tax laws that enhance equity. 





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