No industry is treated more favorably by the federal tax code than real estate. Developers can write off the depreciation of their buildings on very favorable schedules, even while their properties are increasing in value. They can deduct interest paid on the financing of their properties, too. And they can avoid paying taxes when selling properties that have gone up in value by simply swapping properties with someone else, a massive real-estate loophole called a like-kind exchange. It's no wonder that the average real-estate firm pays just over 1 percent in income taxes, compared with an 11 percent average across all industries.
This highly favorable tax treatment leads many experts to speculate that, on any given year, big developers like Donald Trump do not pay any income tax. That speculation was confirmed this past weekend after The New York Times obtained parts of Trump's 1995 tax returns, which showed that in that year he deducted nearly $1 billion in losses and used a tax mechanism called "net operating losses" to carry forward those losses and wipe out his tax income bill for as many as 18 years.
It's difficult to determine exactly where those losses came from and how his tax lawyers worked out his deductions without access to his full tax returns from that year. But Robert McIntyre of the tax fairness advocacy group Citizens for Tax Justice suspects that Trump's $916 million loss carry-forwards "would probably have been worthless" without a provision passed in 1993 that allows wealthy real-estate developers like Donald Trump to take all losses, real or otherwise, from their rental properties and write them off against all their ordinary income-like the $65 million a year that he claims he made in 2011 and 2012 for his reality TV show Celebrity Apprentice, or the money he has made running casinos, licensing his name, and selling ties, vodka, and steaks.
This tax break is not available to your average person with real-estate investments on the side, but almost entirely to a wealthy few who make their primary business in the real-estate industry. It's the product of an aggressive industry lobbying campaign to restore favorable tax treatment for real-estate professionals-after Congress instituted strict limitations in 1986-that was ultimately slipped into a massive tax bill passed by a Democratic Congress and signed into law in 1993 by President Bill Clinton. The provision was touted as a way to help your average professional in the real-estate industry-like a realtor or home-builder-who may have modest amounts of rental income on the side. But the real force behind the change, McIntyre says, were industry titans like Trump who could now use their massive amounts of artificial loss from interest payments and depreciation to entirely avoid paying income tax.
The real-estate industry embarked on a multi-year campaign to build support for the tax provision, complete with generous campaign contributions, extensive lobbying, and pleas from Donald Trump himself, who argued that the recession of the early 1990s resulted in part from Congress's real-estate crackdown in 1986.
"The industry had friends in both parties," says Daniel Shaviro, a tax policy professor at New York University who, while with the bipartisan Joint Tax Committee, helped draft the 1986 tax reforms. "They had lobbyists, they had a nice story, tax reform was no longer a focus, and there was no one on the other side to say otherwise."
The Reforms
In the early 1980s, people in the upper tax brackets often invested in real estate because they were able to write off those paper losses from rental activities against the income from their day jobs as doctors, dentists, and lawyers, thereby dramatically decreasing their income tax bill. A syndicate of investors would put up money for a small down payment on a huge rental property and then borrow most of the cost. Then they would deduct the massive interest payments and depreciation allowances to create the appearance of big losses on their investment, which could be used to wipe away their ordinary income taxes.
The surge of eager investors in real estate led to a ramp-up of development across the country-passive investors loved it because it offered an easy tax shelter and developers loved it because investment money was easy to find. But construction quickly outstripped demand, leading to a glut of "see-through" office buildings with no tenants. The real-estate tax shelters stirred public outrage over tax avoidance among the wealthy, and created a rare moment of bipartisan tax reform efforts that culminated with the 1986 Tax Reform Act. One of the act's sections created new rules that defined all rental income to be "passive," meaning it could not be written off against other income. It applied to real-estate professionals, too-even if they were actively engaged in managing their rental properties. The only exceptions were allowed for small landlords with incomes beneath $150,000 or investors who'd lost no more than $25,000.
The strength and breadth of the reforms caught the real-estate industry off-guard. A politically powerful force on the Hill, it was not used to losing.
Not only did the new provisions turn off the spigot of investor money almost overnight, they also did not allow industry professionals who were materially involved in their operations to write off their losses against ordinary income-something that is afforded to professionals in other industries.
Predictably, industry trade groups sounded the alarm, arguing that Congress had overcorrected with broad new passive-loss rules that treated the industry unfairly and could devastate the real-estate market.
The real-estate industry began lobbying Congress to whittle away resistance. In 1987, The National Association of Realtors (NAR), a lobbying behemoth then with some 750,000 members, began talks with Congress members about how to roll back parts of the 1986 reforms. By 1988, it had convinced Representative Michael A. Andrews, a conservative Texas Democrat, and Representative William M. Thomas, a California Republican, to introduce legislation to restore passive-loss rules for real-estate professionals.
But most Democrats, who had scored a major coup with the 1986 tax reforms, were initially very skeptical of attempts to weaken any provisions.
"I think there was worry if you started picking at parts of it, the whole thing could unravel," says John Buckley, who drafted tax policy on the Hill in the late 1980s and early 1990s before becoming the chief Democratic tax counsel for the House Ways and Means Committee in 1995.
The Congressional Research Service even issued a report on the proposal, expressing concern that it "is targeted to the wealthiest 5 percent of taxpayers, since all or part of the $25,000 exception is already available to those with incomes up to $150,000." The bipartisan Joint Tax Committee estimated that the tax break would balloon the federal deficit by $2.4 billion over five years.
Of course, the industry did not dwell on the massive revenue cost projections of the tax break, or the rarified group of its beneficiaries, or the concern that such a change would reopen real-estate tax shelters. It focused instead on the unfairness of the fact that professionals in other industries could write off passive loss, but they couldn't. The industry argued that the measure would help the average realtor who might have some real-estate holdings of their own but might have too high an income or too small a loss to qualify for the exemptions.
"We refer to it as a fairness provision," Kent Colton, former executive vice president of the National Association of Home Builders told the Los Angeles Times in 1991. "If somebody is an entrepreneur in the real estate and housing development business, they should be treated no differently than people in any other business."
The industry was persistent-and organized. By 1989, the 12 largest real-estate trade associations-representing home builders, real-estate agents, and developers-joined forces to lobby for their special tax breaks, an effort detailed by The Washington Post in 1992. In 1988, the real-estate lobby turned on a faucet of political money. NAR's political action committee contributed $3 million to both Republican and Democratic members of Congress, which made it by far the largest political donor that year. The National Association of Home Builders also contributed $1.5 million.
In 1990, the real-estate industry gave more than $16 million to federal candidates, parties, and outside groups.
Its congressional contributions came to roughly $13,000 per member, while party leaders received hundreds of thousands of dollars. In 1992, a presidential election year, the industry gave more than $30 million, according to the Center for Responsive Politics.
When the economy went into a recession around 1990 and the real-estate market took a dive, industry leaders saw an opportunity to build support for a series of favorable tax breaks, including that special carve-out for real-estate professionals. In the spring of 1991, the industry coalition put out a report boasting about its contribution to national GDP, its employment of millions of workers, and the purported $200 billion in generated tax revenue. The NAR followed up by flying 2,500 real-estate agents to D.C. to lobby Congress.
Lobbying disclosure requirements were much less stringent in the early 1990s, making it difficult to learn which industry groups were lobbying the most and how much they spent, but it is clear that their efforts were paying off. The passive-loss legislation slowly gained support, and by 1991, 326 Democrats and Republicans had signed on in the House. A companion bill in the Senate drew support from 41 senators.
"There was some reluctance among some members at first, but we kept up the drip-drip-drop that eventually wore away the stone," Stephen Driesler, who was the chief lobbyist for the National Association of Realtors (NAR) in the 1990s, told the Post at the time.
Still, as of December of that year, the Bush White House was signaling that it was hesitant to change the passive-loss rules.
Mr. Trump Goes to Washington
As the recession worsened, Congress became more and more concerned-stoked in no small part by the real-estate industry's drumbeating-that the industry had been hit too hard by the 1986 reforms, and that the key to getting out of the recession was by giving real estate more tax breaks. They launched special taskforces and held hearings about what to do.
In late November 1991-in the middle of the economic downturn-Donald Trump went before Congress to testify about the impact of the 1986 tax reform on the real-estate market. In his testimony, Trump fumed about how the government had constrained the real-estate market by cutting off the flow of investors and he urged Congress to restore the passive-loss rules, not just for real-estate developers like himself, but to entirely roll it back to pre-1986 levels: "Something has to be done. It has to be brought back, it has to be reformed, it has to be taken care of," he declared.
"The fact that the one word that nobody up on the panel has mentioned is the word depression, and I truly feel that this country right now is in a depression," Trump said at the beginning of his testimony. "It's not a recession. People are kidding themselves if they think it's a recession. You look at what's happening in the automobile business and the-in the retailing business, and the retailing business in any part of the country virtually is a total disaster. But in the real-estate business, we're in an absolute depression, and one of the reasons we're there is what happened in 1986."
Trump complained about the lack of incentive to invest in real estate. "I was asked to come by the Chairman, and I make this plea that, if something isn't done to put the incentive back-I mean, we're no different right now than the Soviet Union. They have no incentive, and we have no incentive. And if something isn't done to quickly put the incentive back, this country is going to be in very deep problems. It already is, but it's going to get far worse."
He contended that the "syndication of real estate was a very positive thing"-referring to tax incentive for rich doctors and dentists to invest in development. The problems began, Trump said, when people began using the phrase "tax shelter" as opposed to calling it a real-estate investment. "So they heard the word tax shelter and politically they didn't like that word and they said, 'Let's get rid of tax shelters.' But when they got rid of tax shelters, they got rid of people investing in low and moderate income housing and lots of other good things, and I think you're going to have to go back."
Representative Frank Guarini, a New Jersey Democrat and former real-estate developer, brought up Andrews's bill that would exclude real-estate professionals from the passive loss rules, and asked whether Trump thought Congress should expand it beyond real-estate developers. "Well, I think it has to go beyond developers because we're going to get a lot of the liquidity from people outside that are making money and can invest in real estate. Right now they can't invest in real estate," Trump said. "As far as the passive laws, I did hear things about it in 1986 passive laws, but nobody ever thought it would be possible for something like this to get passed, and all of a sudden it's passed and everybody, including the United States government, is left holding the bag, and a lot of other governors, by the way."
Crossing the Finish Line
Just over a week after Trump's congressional testimony, the real-estate coalition descended upon the White House to meet directly with President George H.W. Bush and insist that he grant them a handful of special tax provisions for their respective members. As The Washington Post reported then, the one that they all agreed was critical was restoring the passive-loss rules for real-estate professionals.
The pressure appeared to work. A few months later, in his State of the Union address, Bush declared: "Real estate has led our economy out of almost all the tough times we've ever had." (Never mind that real estate did nothing to lead the nation out of the Great Depression.) He called on Congress, then controlled by the Democrats, to pass a major tax bill that would cut taxes for the middle class, as well as pass a number of special-interest provisions like modifying the passive-loss rules to exempt real-estate professionals. In early 1992, Democrats passed a tax bill that included that provision, but it also hiked taxes on the wealthy. Bush vetoed it before it even reached his desk.
More than a year later, with Bill Clinton now in the Oval Office, the new administration was pushing a tax bill that raised rates on the wealthy and was vehemently opposed by the Republican Party, as well as a number of Democrats. But the real-estate lobby's influence had not waned. The passive-loss exemption remained in the bill.
"It could easily have been there to [enable Democratic leaders to] assemble a majority. Some may call it buying votes, I would call it a consensus package," says Buckley. "There were a lot of bad things in that bill. That may have been the price required to get it through." It did get through-just barely. With no Republican support, the bill passed the House by two votes, and Vice President Al Gore had to vote to break to deadlock and get it through the Senate.
DESPITE INDUSTRY TALKING POINTS, real-estate experts are skeptical that the rule change had any substantive impact on the market, let alone whether it came anywhere close to growing the economy by 7 percent, as the industry had projected. But the industry's powerful lobbying machine, along with pressure from wealthy real-estate magnates like Trump, greased it through regardless. It continues to be one of the biggest ways that real-estate developers like Trump escape paying taxes, experts say.
The industry's influence has only grown as lobbying becomes more critical to protecting special-interest provisions and as regulations restricting political money have loosened. By 1998, the first year the Center for Responsive Politics began tracking lobbying expenditures, the industry was spending almost $30 million a year lobbying the federal government. In 2014, that number had grown to more than $95 million. That same year, it contributed $55 million to congressional candidates.
"They have built their business around tax breaks and they fight hard for them," says McIntyre. "And everybody's got real-estate developers in their district."
