Sunday, April 23, 2017

Adam Ruins Everything - Malls - How are they tax shelters?

The series "Adam Ruins Everything" (a fantastic product) on TruTV had an episode "Adam Ruins Malls" and the episode referenced a 1996 paper, Thomas W Hanchett that makes the argument that a 1954 law, intended to stimulate the economy by encouraging business to pay less income tax by counting depreciation of factory machinery, allowed for something called "sum-of-the-years'-digits accelerated depreciation", which references a 1955 Architectural Forum Miles L Colean statement that shows how this works (and it was only for new construction, thus why there had to be new malls).

Say you buy a mall in 1955 for one million dollars. 1,000,000

You rent it to tenants and charge them enough to make fifty thousand dollars a year. 50,000.

I am literally making this up. I have no idea how much stuff would have cost then.

So let's pretend, you have decided, the entire building will only last 5 years. So here is how you depreciate it:

Add all the years it will last together, 1 + 2 + 3 + 4 + 5 = 15 (remember we decided it would last 5 years).

So in the first year (1955 in our example) the "sum-of-the-years'-digits" formula, the value depreciates by 5/15. (5 is the total years, 15 was the sum of those years digits).

In the second year (1956 in our example), the value depreciates by 4/15.

Year three, 3/15.

Year four, 2/15.

Year five, 1/15.

Did you catch that the first year was a huge depreciation compared to the last year? 5 times as large to be specific.

5/15 is one third: 33.3%

4/15 is 26.6%

3/15 is one fifrth, 20%.

2/15 is 13.3%

1/15 is the remaining, 6.6%

So what's 33.3% of a million? $333,333. Remember that $50,000 you were making in rent from the tenants? Well according to the depreciation, you didn't earn any money that year. No Tax! Even though you took home $50,000.

Year two, 26.6% of a million: $266,666. Again, you took home $50,000 but again, no tax!

Year three, 20%, $50,000, again, no tax.

Year four, 13.3%

Year five, 6.6% $66,666, again, no tax.

Year 6? Sell it, for one million dollars, maybe even more!

So let's recap. Five years at $50,000 is $250,000, and NO TAX! And if you sell it for the same price as you bought it, no loss of your initial capital.

FYI: This changed in 1968, to make it better, then changed to make it worse in 1981. If you'd like to know more, I'd recommend the paper (linked above).

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