The Republican Presidential nominee is apparently not as shrewd a businessman as he wants everyone to believe. It has been published that on his 1995 tax return he reported total accumulated losses of almost $1B!
I’ll leave it to the reader to decide whether they want to install a president who alone reported almost 2% of total losses reported by individuals in the United States for that year. After all, he runs a campaign based on his credibility as a businessman and promising fixing the US debt and deficit problems, so his staggering net loss in the 1990’s must attest to his experience in that field… Not for success, though. But that’s politics.
Let’s talk about the loss itself. How does it work, and why it is actually good for us to have that mechanism in general.
The NOL (Net Operating Loss) for individuals allows people who in a certain year had negative income (i.e.: lost money on a business or investment) claim that loss on prior (up to 2 years) and future tax returns (up to 18 years). In total, an individual who incurred a loss could offset the income in 20 other years with that loss. That is why the media reports that Trump could have not paid any income taxes for up to 18 years after 1995.
How could Trump accumulate such a loss? It doesn’t necessarily have to be any real money lost. In fact, most likely it is not. This may be a “paper” loss resulting from depreciation deductions on real-estate holdings.
What is depreciation?
When a real estate investor buys a building, it becomes an asset of a certain value. But, buildings tend to deteriorate and “die”, as such – they have a “useful life”. The investor will deduct the value of the building from the income it generated of the period of that useful life. But what if the building hasn’t generated enough income? The investor can still deduct the value, having “net income”. While for small-scale retail investors the negative income from rental properties cannot be deducted from their other income – for “professional” investors who treat real estate as active business and not just passive rentals – it can. Thus, Trump, whose real estate holdings didn’t generate enough income to cover for the depreciation expenses, got to have “negative” income on his tax return, while most of us would probably never be able to do that.
Why is it good then?
Generally, NOL is a tool helping compensate the risk the entrepreneurs are taking when starting a business. As businesses don’t always start generating positive returns right away, and sometimes ever, entrepreneurs end up with NOL at some point in their business life. While they don’t get a tax refund from the IRS on their loss at that year (mirroring them paying the taxes on the positive income), they do get to enjoy the tax benefit of the loss – when they start earning income (or from the income taxed recently, in the previous 2 years).
Without the ability to provide a tax benefit to the loss similarly to the tax cost of the gain – there would be a significant hurdle for people to start and enter businesses. In effect that would mean that the tax on the business income would be higher, since the loss would become a post-tax loss while the gain is pre-tax. This would especially hurt people who are starting businesses on their own, and without deep pockets and millions of inheritance and loans from the family that Mr. Trump had enjoyed.
So overall, the NOL as a concept is not a bad thing. However, Trump having such huge losses while he claims to be so successful as a businessman is definitely something to think about!
Your Little Advisor
PS: Don’t forget to register to vote, if you haven’t already! The clock is ticking!