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Financial Alchemy: Depreciation, Passive Losses, Real Estate Professionals, And Uncle Sam (Part 5 — A Brief Digression)

Kevin Boer, Broker Owner, 3 Oceans Real Estate, Inc. ()

October 31st, 2007 · No Comments

Looks like my big idea won’t be unveiled till part 6!

warning3.jpgAll together now:  I am neither an accountant nor a tax attorney.  More importantly, I am not your accountant or tax attorney.  What follows is simply my layman’s understanding of a particularly obscure part of the tax code.  Before you try any of the below, be sure to consult with the appropriate professional.  ‘Nuff said.

Let’s take a brief digression into the arcane world of sale-leasebacks of depreciable assets from government entities to private entities.  Financial alchemy at its best!

Here’s how it works…*

A government entity — say, the City of New York — has a very large depreciable asset on its books — say, the subway system.  Depreciable assets, as we’ve seen, are a pretty valuable way of reducing one’s tax bill.  Problem is, the City of New York, as a tax-exempt institution, doesn’t actually have a tax bill that needs reducing!

Across the street is a private entity — say, Goldman Sachs — with a boatload of taxable income, sitting there in public view of the salivating money-grubbers at the IRS.  If Goldman Sachs owned that subway system, now we could take advantage of that depreciation.

Voila!  A perfect opportunity for financial arbitrage, creating a win-win for the City of New York and Goldman Sachs at the expense of the taxpayer.

The City of New York sells the subway system to Goldman Sachs for, say, $10B.  An instant later, the City of New York leases the subway system back from Goldman Sachs — good thing, too, since Goldman Sachs may be good at many things, but running subway systems isn’t one of them!

Goldman Sachs now has a $10B depreciable asset on its books.  I have no idea what the IRS’s depreciation timetable for subway systems looks like, but trust me, depreciating $10B will spit off many, many millions of dollars of tax savings each year.

The relationship between this piece of tax arcana and real estate depreciation?  Stay tuned for episode 7 of my ever-expanding trilogy.

* This example is completely ficititious.  As far as I know, Goldman Sachs does not own the New York subway system.  Deals similar to this, however, happen quite frequently between public and private entities.  See, for instance, this (rather dated) report from the Congressional Budget Office.

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