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Want to Make Millions and Pay No Taxes? Try Real Estate

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Real estate is a cyclical business. Markets crash. Deals sour. But hard landings are rare for a savvy property mogul, thanks to the U.S. tax code.

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Take Harry Macklowe, a New York City developer. Macklowe, 81, hasn’t paid income tax since the 1980s, according to a court opinion in his divorce proceedings issued in December. The ruling, which also divided luxury homes and an art collection worth more than $650 million between Macklowe and his ex-wife, Linda, doesn’t suggest the couple did anything wrong to avoid paying income taxes. Rather, it highlights the special perks available to property investors in the U.S.—advantages that have expanded under the tax law signed in 2017 by Donald Trump, America’s real estate developer president. “The real estate industry is notorious for throwing off lots of deductions, and real estate developers are notorious for paying very few taxes,” says Steven Rosenthal, a senior fellow with the Urban-Brookings Tax Policy Center. “As Leona Helmsley said, ‘Only the little people pay taxes.’”

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As Democrats in Congress seek Trump’s tax returns, Macklowe’s divorce case provides a hint at what they might find. Real estate moguls have a range of strategies available to reduce or postpone their tax liabilities. Harry Macklowe didn’t respond to a list of questions forwarded to him by his spokesman. Linda Macklowe declined to comment.

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Over more than a half-century of investing in New York real estate, Macklowe built a reputation as a dealmaker willing to take big risks. With Linda, he spun real estate profits into an art collection with hundreds of pieces, including Andy Warhol’s Nine Marilyns and sculptures by Alberto Giacometti. In the 1980s, Macklowe gained notoriety after his company demolished single-room occupancy buildings near Times Square in the middle of the night; he built a hotel on the site, named it after himself, then ended up surrendering the property to the lender a few years later.

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Macklowe rebuilt his business, buying the General Motors Building for $1.4 billion in 2003, and winning acclaim for developing an Apple Store beneath a transparent cube on the building’s Fifth Avenue plaza. In 2007, Blackstone Group LP bid to acquire a real estate investment trust called Equity Office Properties Trust. As part of the deal, Blackstone sold seven New York office buildings to Macklowe, who financed the purchase with $7 billion in debt. Within a year the global financial crisis prevented him from refinancing the debt, and he lost control of the properties, according to The Liar’s Ball, a book by Vicky Ward about Macklowe and the history of the General Motors Building.

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Undaunted, Macklowe teamed up with deep-pocketed investors on a series of projects. They included construction of 432 Park Ave., the tallest residential building in the Western Hemisphere when it was completed in 2015, where he recently displayed 40-foot-tall photos of himself and his new wife. Now he’s planning a skyscraper east of Manhattan’s Fifth Avenue that would be among the tallest office buildings in the world. “New York is a market that can go up and down, and he’s lived it up and down,” says Donna Olshan, president of the residential brokerage Olshan Realty Inc. “He keeps trying to swing for the fences, and you’ve got to admire that.” Those ups and downs generated the losses that, along with other tax breaks for property investors, could have helped keep Macklowe’s tax bills at zero.

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Macklowe’s tax affairs emerged in his divorce case because the two parties disagreed on how to value the tax credits and liabilities he’d generated during his career. Linda claimed her ex-husband used $448 million of net operating losses to defray income taxes from 2008 to 2015, according to the court opinion. That helped the couple reduce their taxes and maintain a lavish lifestyle, which included homes at the Plaza Hotel and in East Hampton as well as the purchase of a yacht for more than $23 million.

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Those trappings might not have been available if Macklowe had made his fortune in another industry. The U.S. tax code is designed to measure profitability over time, allowing businesses to write off losses in one year against income in the next. For most companies, that provision is limited to losses on their own capital as opposed to losses on borrowed money. “There’s a general rule that you’re not supposed to be able to claim losses for more than you put into a deal,” says Steve Wamhoff, director of federal tax policy at the Institute on Taxation and Economic Policy, a left-leaning think tank. “Real estate is the exception.”

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Macklowe personally guaranteed a portion of the debt he used to acquire the Equity Office portfolio, so he may not have needed to take advantage of the rules regarding losses on borrowed money. He likely took advantage of other perks, including tools for deferring capital gains and the ability to claim depreciation on appreciating assets. Those practices are common in the real estate industry. During a televised presidential debate in 2016 with Hillary Clinton, Trump was asked if he used a $916 million loss from his casino business to defer taxes. “Of course I do,” he replied. In the same debate, Trump also cited depreciation rules as a technique he used to reduce taxes. “I love depreciation,” he said.

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Farmers and factory owners can depreciate certain items, too, but tractors and conveyor belts don’t gain value over time. The value of central business district office buildings in the U.S. more than doubled from the fourth quarter of 2000 to the same period of 2018, according to a commercial property price index compiled by Real Capital Analytics. A property owner might write off about half of a building’s value over the same period using a standard depreciation schedule. “It’s obviously not an accident that real estate tends to be very politically powerful in Washington and also in New York,” says Daniel Shaviro, a tax professor at New York University School of Law. “They have money, they have access. They’re important players. Politicians want their support.”

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The tax law signed by Trump included several new benefits for the real estate industry. Many real estate investors report business income on their personal returns, and the law created a 20 percent deduction for such pass-through entities—cutting taxes for property owners while excluding other businesses. While the law limited the amount of income that can be offset by past losses at 80 percent, it also created a feature that allows real estate investors to defer or even eliminate capital-gains liabilities by pouring money into areas designated as “opportunity zones.” While the break is intended to spur development in poor areas, officials in some states have conferred the designation on up-and-coming neighborhoods.

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The Macklowes’ divorce shows just how long-lasting tax perks can be. The developer still held about $275 million in net operating losses when the divorce action began in 2016. And in addition to carrying forward losses, he’d also managed to limit the tax liability from his gains. He sold the General Motors Building in 2008 to an investor group led by Boston Properties Inc. in a $2.8 billion transaction designed to defer almost $1 billion in capital-gains tax, according to the divorce court opinion. Harry’s attorneys argued that Linda should share potential capital-gains taxes that would be triggered if Boston Properties sold the General Motors Building. Linda’s lawyers said her ex’s remaining net operating losses should be valued at $126 million, based on their estimates of Harry’s expected earnings.

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The judge ultimately divided almost $100,000 in books, $400,000 in silver, and more than $3.5 million in jewelry and decided the net operating losses should be applied to capital gains arising from the sale of the couple’s art collection. Both sides should also share any future tax liabilities generated by a resale of the General Motors Building, even though the nature of the deal, not to mention the Macklowes’ advanced ages, suggest they will never be realized. “The husband acknowledges that it is unlikely these deferred liabilities will ever come due during the parties’ lifetimes,” the opinion said. —With Katya Kazakina