Is Tax Math Fair? And does anyone actually understand it?

Accountant · Atlanta, GA · Member since 2015 · 1k+ posts · 1k+ votes

7y

The question is simple but the answer is not.

We could easily turn this question into an 8 hour long discussion.

OP

Real Estate Broker · Hartsville, SC · Member since 2015 · 174 posts · 69 votes

7y

Originally posted by @Christopher Smith:

Fair to whom?

Good question! I don't know. I don't understand what's happening. lol! Do you not feel completely lost in all this?

As a Real Estate Agent, who is a good at my craft, I understand the contracts very well. I work a deal and have confidence in what I'm doing. I know a lot of my clients are completely lost when they start and have only a basic understanding during the process. (I educate them as much as they want and end up spending a ton of time with some of them) They rely on my understanding and confidence. I can't say that I completely understand every clause in a real estate contract, but there's nothing in there that I just take on blind faith. I get it. And overall, I think the contracts are fair. Before I had this level of understanding, I would have the same questions about a Real Estate Transaction. Why are these clauses in there? Why only this many days? Who does this protect or benefit? At this point, I look at the transaction overall, and can step back and say, "yep, I get it." This is pretty fair overall. I do X and Y to tip the scales in my clients favor, etc. That's what I wonder about the whole tax system. Do people actually "get it"? And if they do, I wonder if they step back and say, "yep, that's pretty good overall", or if they think, "man, these rules are terrible and it is what it is?"

OP

Real Estate Broker · Hartsville, SC · Member since 2015 · 174 posts · 69 votes

7y

Originally posted by @Eamonn McElroy:

The question is simple but the answer is not.

We could easily turn this question into an 8 hour long discussion.

Eamonn, as an accountant, do you understand the seemingly arbitrary numbers and exception, etc, or do you just accept them as the rules you have to play by?

Nicholas AiolaBusiness Member

CPA & Investor · New York, NY · Member since 2017 · 1k+ posts · 1k+ votes

7y

@Cameron Price As you mentioned, it's definitely too deep of a topic to condense the intent and decisions behind writing ~80k pages of the tax code but, to put it very simply...

Tax dollars are one thing - the money the government collects from income taxes is used for Social Security, Medicare, national defense, transportation, eduction, and so on and so forth. A quick Google search will give more detail on that.

But as for the Code itself - in a broad sense, the tax code is designed to incentivize you to put their money where the goverment wants you to put it. We've all heard that manipulating (legally, of course) the tax code is how the rich stay rich. How? By following the "instructions" of the tax code. For example...

Real estate is a tax-advantaged investment in several facets (depreciation, capital gains, 1031 exchanges, opportunity zones, the list goes on and on). Why? The goverment wants people to provide housing to others.
Corporate tax rates were slashed and pass-through deductions were implemented in the TCJA to promote entrepreneurship and start ups.
Energy-efficient tax credits exist to encourage people to go green and purchase environment-friendly goods and products.
I don't need to explain why there is an abundance of oil and gas tax credits and deductions.

Where you see a tax credit or deduction, a trained eye sees an opportunity.

If you (or someone you hire) knows the tax code, how to read it, and how to apply it, you are able to structure your investments, businesses, and financial moves in a tax-efficient manner.

So, I guess, to answer your question - in my opinion, the tax code is fair but only if you know how to navigate it.

Again, this is an overly simplistic summarization. I'm sure others will have more info and opinions to add.

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Nicholas AiolaBusiness Member

CPA & Investor · New York, NY · Member since 2017 · 1k+ posts · 1k+ votes

7y

Originally posted by @Eamonn McElroy:

We could easily turn this question into an 8 hour long discussion.

Uh oh, I guess I'll put on my seatbelt.

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Accountant · Atlanta, GA · Member since 2015 · 1k+ posts · 1k+ votes

7y

@Cameron Price

"do you understand the seemingly arbitrary numbers and exception, etc, or do you just accept them as the rules you have to play by?"

If you're asking if I understand the legislative intent of tax law, yes, I understand some of the legislative intent of some tax law. It would be impossible for a tax CPA/EA to understand all of the legislative intent. I imagine an analogy would be asking an engineer if they have memorized the mechanics of every machine created over the past 100 years. That's a high goal. Usually workers focus on a niche or two now at days.

The preambles to Treasury Regulations usually explain the writers methodology and what they're trying to accomplish. That's a good source for practitioners.

If you understand the intent and thought process of the writers, you can take it up a level for clients and get creative with tax planning and positions taken.

Accountant · Atlanta, GA · Member since 2015 · 1k+ posts · 1k+ votes

7y

@Nicholas Aiola

Don't forget your earplugs. They're absolutely necessary for this type of discussion. ; )

OP

Real Estate Broker · Hartsville, SC · Member since 2015 · 174 posts · 69 votes

7y

@Nicholas Aiola, that was a very helpful response. Thank you. 80K Pages is insane!

You said the tax code is fair if you know how to use it. That's a lot of what I wanted to know.

I had to pay depreciation recapture taxes yesterday. That's one of those things that blows my mind. Why did you give me a deduction if you are going to make me pay it back? To use that as an example, If you had to pay depreciation recapture taxes, knowing what you know, you would feel ok about it? From my ignorant perspective, I didn't really get the deduction I thought I did, If I have to pay some of it back. There has to be some logic that makes sense there, but I don't get it. You do, and are good with it? I know my feelings don't mean anything, but I'm fascinated by this.

OP

Real Estate Broker · Hartsville, SC · Member since 2015 · 174 posts · 69 votes

7y

@Eamonn McElroy, I've never heard of Preambles to Treasury Regulations. So they basically have to explain their logic? If/ when you read them, you normally think it makes sense?

Tom Makinen

Member since 2019 · 226 posts · 115 votes

7y

No offense but you live in South Carolina. Try living in California where you got shafted hard by the salt tax limit and our property value got capped by the mortgage interest deduction. I paid an extra five figures in taxes without changing much.

Also are you sure you have to pay because they changed the tax withholdings? In theory most people not in blue states or super poor got a slight tax cut, look at your effective tax rate between 2017 and 2018. I should add people with lot of misc deductions got shafted too.

Dave FosterBusiness Member

Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes

7y

But I thought next year the tax form was going to be the size of a post card?? How will we generate 8 hours of discussion on that @Eamonn McElroy :)

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Robert C.

Investor · San Francisco, CA · Member since 2016 · 338 posts · 444 votes

7y

@Cameron Price, Man, talk about can of worms!

As with anything political, 50% can argue reasons for and 50% can argue the bad. Yes there were probably special interests involved in creating this stuff, and yes there are probably reasons as to why certain loopholes exist - it’s not mutually exclusive.

My total guess is that depreciation rules already existed in other businesses so made sense but the recapture was added in to encourage continued long term investment and discourage unfair advantage through sales. Maybe?

1 Reply

OP

Real Estate Broker · Hartsville, SC · Member since 2015 · 174 posts · 69 votes

7y

Originally posted by @Tom Makinen:

No offense but you live in South Carolina. Try living in California where you got shafted hard by the salt tax limit and our property value got capped by the mortgage interest deduction. I paid an extra five figures in taxes without changing much.

Also are you sure you have to pay because they changed the tax withholdings? In theory most people not in blue states or super poor got a slight tax cut, look at your effective tax rate between 2017 and 2018. I should add people with lot of misc deductions got shafted too.

No offense taken man. I know a lot of people pay way more than I do. I probably should have mentioned I'm self employed and pay in once a year. I have no idea the impact the new laws have on me, as my taxable income was significantly higher in 2018 than in 2017.

But that's exactly my point. Somebody somewhere figured it was right for you to have a specific limit on your mortgage interest deduction. I wonder who really understands why you got limited and why someone else does not. And why is there a limit? There has to be logic to that somewhere, and it sounds like nobody really understands it all, but some people understand specific portions of it. At 80K Pages, I doubt anybody has a deep understanding of all that!

Craig Jeppesen

Rental Property Investor · Chubbuck, ID · Member since 2018 · 532 posts · 466 votes

7y

The simple answer is taxes are different for everyone, they are not fair for everyone, and they are super complex and get worse every year due to politics and politicians agendas, etc etc etc.

You will not get the answer you are looking for.

1 Reply

OP

Real Estate Broker · Hartsville, SC · Member since 2015 · 174 posts · 69 votes

7y

Originally posted by @Robert C.:

@Cameron Price, Man, talk about can of worms!

As with anything political, 50% can argue reasons for and 50% can argue the bad. Yes there were probably special interests involved in creating this stuff, and yes there are probably reasons as to why certain loopholes exist - it’s not mutually exclusive.

My total guess is that depreciation rules already existed in other businesses so made sense but the recapture was added in to encourage continued long term investment and discourage unfair advantage through sales. Maybe?

So, in general, you think the tax code is political and not unbiased mathematical formulas? That's part of what I'm trying to figure out. I'm sure different parts are driven by each.

OP

Real Estate Broker · Hartsville, SC · Member since 2015 · 174 posts · 69 votes

7y

Originally posted by @Craig Jeppesen:

The simple answer is taxes are different for everyone, they are not fair for everyone, and they are super complex and get worse every year due to politics and politicians agendas, etc etc etc.

You will not get the answer you are looking for.

Thanks for the response. I think that is part of the answer I'm looking for. So, if this thing is 80K pages, politically influenced, super complex, and nobody fully understands what's going on anymore, how do people even make decisions? Do politicians, economist, lobbyist, etc just focus on a specific piece they want to change and forget how it impacts it as a whole?

Irina Belkofer

Real Estate Broker · Cleveland, OH · Member since 2017 · 719 posts · 658 votes

7y

Originally posted by @Cameron Price:

@Nicholas Aiola, that was a very helpful response. Thank you. 80K Pages is insane!

You said the tax code is fair if you know how to use it. That's a lot of what I wanted to know.

I had to pay depreciation recapture taxes yesterday. That's one of those things that blows my mind. Why did you give me a deduction if you are going to make me pay it back? To use that as an example, If you had to pay depreciation recapture taxes, knowing what you know, you would feel ok about it? From my ignorant perspective, I didn't really get the deduction I thought I did, If I have to pay some of it back. There has to be some logic that makes sense there, but I don't get it. You do, and are good with it? I know my feelings don't mean anything, but I'm fascinated by this.

Nothing is fair about taxes: the country needs money to function and it gets it through taxes.

However, if you understand their intention and the system, you can play it better.

In your example, depreciation recapture exists to get back some part of the advantage you’re given because you’ve sold your property at the right time (with gain). During the time when you were using depreciation, it was expense decreasing your taxes but you never paid it. When you go to get a mortgage, the banker will add the depreciation to your income which increase your buying power. Is that fair? To people who work on W-2 and don’t have such advantages?

If you learn tax system and can navigate toward more advantageous businesses, you’ll see that you can pay less taxes on the very same amount of income.

After all, if you do pay taxes, you might get some income. It’s fair

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Accountant · Atlanta, GA · Member since 2015 · 1k+ posts · 1k+ votes

7y

@Dave Foster

You write really really small Dave. ; )

Nicholas AiolaBusiness Member

CPA & Investor · New York, NY · Member since 2017 · 1k+ posts · 1k+ votes

7y

@Cameron Price Depreciation recapture is a tricky one. The theory makes sense - you shouldn't be able to benefit from the preferential long-term capital gain tax rates on the portion of the gain that you've already benefited from by means of a depreciation deduction against rental income taxed at ordinary rates. That would mean you are receiving a tax deduction equal to your ordinary tax rate (depreciation expense) plus preferential LTCG rates on that portion of the gain upon sale.

Some not-so-bad depreciation recapture scenarios...

The tax rate on the unrecaptured Section 1250 gain maxes out at 25%. So, let's say you were in the 32% tax bracket in the prior years in which you claimed the depreciation deduction You would only recapture that depreciation at a tax rate of 25% in the year of sale, meaning you still received a net tax benefit.

You also receive the benefit of the ability to use and grow the tax-free cash flow generated as a result of depreciation year after year.

Additionally, you can defer depreciation recapture by doing a 1031 exchange.

These are all high-level points and the effects may differ depending on your specific situation but it's important to be aware of it as a buy and hold investor.

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OP

Real Estate Broker · Hartsville, SC · Member since 2015 · 174 posts · 69 votes

7y

@Irina Belkofer, maybe I'm too dumb to grasp some of these concepts, because that's exactly the type of scenario I ponder. Did that whole depreciation example fully compute in your head? I mean, do you understand the logic of recapturing and why a banker would add it back? Or, do you just know that it how it works, and you just follow suit?

There's formulas being used that are based on some logic, and I can't figure out if people just accept them, or if they really understand them. And also if people in general feel good about them. (as good as you can feel about paying taxes)

Would you feel good about that exact depreciation recapture example if that was your money or would you feel shorted? Or would you be just as confused as me? lol.

OP

Real Estate Broker · Hartsville, SC · Member since 2015 · 174 posts · 69 votes

7y

Originally posted by @Nicholas Aiola:

@Cameron Price Depreciation recapture is a tricky one. The theory makes sense - you shouldn't be able to benefit from the preferential long-term capital gain tax rates on the portion of the gain that you've already benefited from by means of a depreciation deduction against rental income taxed at ordinary rates. That would mean you are receiving a tax deduction equal to your ordinary tax rate (depreciation expense) plus preferential LTCG rates on that portion of the gain upon sale.

Some not-so-bad depreciation recapture scenarios...

The tax rate on the unrecaptured Section 1250 gain maxes out at 25%. So, let's say you were in the 32% tax bracket in the prior years in which you claimed the depreciation deduction You would only recapture that depreciation at a tax rate of 25% in the year of sale, meaning you still received a net tax benefit.

You also receive the benefit of the ability to use and grow the tax-free cash flow generated as a result of depreciation year after year.

Additionally, you can defer depreciation recapture by doing a 1031 exchange.

These are all high-level points and the effects may differ depending on your specific situation but it's important to be aware of it as a buy and hold investor.

I can tell by this response, that at least on depreciation recapture, that you do understand the theory and logic behind the rules! I would assume you have this same level of understanding on most basic accounting principles. I, unfortunately, have a hard time grasping this stuff. Is there a good resource for someone like me who wants to REALLY understand some of these basic accounting principles and not just learn rules? Rules don't help me until I grasp the underlying concepts and theories like you demonstrated here.

Irina Belkofer

Real Estate Broker · Cleveland, OH · Member since 2017 · 719 posts · 658 votes

7y

@Cameron Price I personally don’t understand why it’s confusing.

If you play cards or chess, are rules confusing to you or you just learn the rules and try to win?

Nobody feels good about paying taxes, that’s the reason why people learn the rules and avoid paying taxes LEGALLY whenever it’s possible. Maybe my background as an accountant or just because I do understand financial systems better than something not so logical - I don’t have problems with comprehending it.

As a real estate investor and business owner you have huge amount of advantages vs people working on W-2.

You deduct almost everything on your sch.C, you don’t pay social taxes on your sch.E, you can defer capital gain taxes through 1031 exchange. That’s one hell of a deal to create business which pay much less taxes than people working 40 hours per week and couldn’t deduct even driving to work....lol

I’m from Russia where income tax is 13% flar rate and people still don’t like paying it.

There is no such great system like here - all these deductions, exemptions.......I don’t even pay state income tax in my state because small businesses are exempt. What not to like?

You just have to learn the rules and then create your own tax empire to avoid unnecessary taxes. Legally.

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Russell BrazilBusiness Member

Moderator

Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes

7y

Lobbyist lobby for a tax break for X. Could be any tax break for anything. Then that gets sent to the Congressional Budget Office who does an analysis that Y Dollars will be lost or gained. Then whoever wrote that law realizes that dollar amount is just too large, so then they end up putting a limitation on the deduction, or a phase out or the such. That is where pretty much all the limitation end up coming from, an arbitrary number to limit losses on government revenue after a CBO study of proposed legislation.

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Nicholas AiolaBusiness Member

CPA & Investor · New York, NY · Member since 2017 · 1k+ posts · 1k+ votes

7y

Originally posted by @Cameron Price:

Is there a good resource for someone like me who wants to REALLY understand some of these basic accounting principles and not just learn rules?

Change professions and obtain some hands-on experience ;)

Kidding...kind of. There are a few books out there that scratch the surface - I enjoyed Tom Wheelwright's book Tax-Free Wealth. I would say that's a good start.

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