Originally published on Forbes.com.
Donald Trump said a magic word three times in the heated debate last night – “depreciation”. In answer to Anderson Cooper’s question on how many years he has avoided paying federal income tax, Trump responded
No, but I pay tax, and I pay federal tax, too. But I have a write-off, a lot of it’s depreciation, which is a wonderful charge. I love depreciation.
That got me almost excited as Donald promising to throw Hillary in the slammer after he is elected and even more excited than, well, you know.
I’m going to give you a little elementary accounting, which you can skip if you want, but it is important. Trump’s refusal to be bound by elementary accounting, which as a graduate of Wharton he must understand, is the source of much of his success.
Some Elementary Accounting – Read After Coffee
The fundamental accounting equation is assets (the stuff you own) equals liabilities (the amount you owe) plus equity (the net of the two, which might be negative). Every transaction has two sides to it – a debit and a credit. They need to be equal. Back in the pre-computer days, much of the time of accountants and bookkeepers was spent making sure the debits equaled the credits. It was beyond tedious toiling into the night consuming forests worth of adding machine tape trying to find why you were out of balance. And it was immensely satisfying, when you were finally in balance.
Here is the part that is the most confusing, at least to me. On the balance sheet, debits are good. Those are your assets. Credits are good if they go to equity. That would mean that you put something in. If the credit goes to liabilities though, it is not so good. That means you borrowed to get your asset.
Then there is the income statement which is where all the action is. All the debits and credits for the income statement are happening within the equity section. At the end of a period (usually a year) the net effect of them is “closed” to an account in the equity section (often “retained earnings”). That’s where the term “closing” comes from.
If you can scrape up some fragments of your early training in algebra, it might help here. On the income statement it is credits (revenue) that are good and debits (expenses) that are bad. Well, that is true for having a nice looking income statement for bankers and investors. When it comes to tax reporting you prefer it the other way around.
The Accounting Concept That Trump Loves
And that brings us to depreciation , the accounting concept that Trump loves so much. Besides his expression of love last night, depreciation is featured much in Trump: The Art of the Deal
…..I don’t have to please Wall Street, and so I appreciate depreciation. For me the relevant issue isn’t what I report on the bottom line, it’s what I get to keep.
Back to elementary accounting, bottom line is “net income”, the amount that is closed to equity at the end of the year for both your tax basis balance sheet and your GAAP (generally accepted accounting principles) balance sheet. GAAP is what gets reported to investors. And tax basis is what goes to the IRS. If you are really nerdy, you will read the notes to the financial statements that reconcile the two numbers.
Under both GAAP and the income tax basis of accounting, assets that have a limited useful life are subject to depreciation. Their cost is charged (written off) to the income statement over a period of time. Debit depreciation (an expense) credit accumulated depreciation (kind of a negative asset that offsets the basis of the asset being depreciated). In real estate, buildings depreciate. Land does not.
On conventional financial statements, all depreciable assets are on a death march. Their only hope is to be sold which will give them a new lease on life on some other balance sheet or continued in the twilight world of fully depreciated assets that show up and do their job every day in the business operation but are of no account to the accountants.
Buffett Versus Trump On Depreciation
In his annual letter to shareholders of Berkshire Hathaway (which I should disclose constitutes a large proportion of my unspectacular net worth), Warren Buffett gives a much more nuanced view of depreciation. It makes me feel good that Warren Buffett whose net worth is a double-digit multiple of Trump’s integrates elementary accounting into his thinking about business. To Buffett, the net worth that conventional accounting finishes with is a starting point in business analysis. Buffett will add back some depreciation and even boost some parts of it. To Trump, it is largely irrelevant except for the tax effect, which he loves. If all accounting concepts were women, depreciation would be the fairest of them all.
A Very, Very Great Balance Sheet
The Trump principles of accounting are different. They are actually not peculiar to Trump. They are bred into large numbers of people starting with the ones staying up late at night watching commercials on how to buy real estate with no money down. The income statement is of little importance. What is important is the balance sheet, which Trump mentioned three times in the debate last night.
I have a very, very great balance sheet , so great that when I did the Old Post Office on Pennsylvania Avenue, the United States government, because of my balance sheet, which they actually know very well, chose me to do the Old Post Office, between the White House and Congress, chose me to do the Old Post Office.
One of the primary area things, in fact, perhaps the primary thing was balance sheet.
Trump Principles Of Accounting
A Trump balance sheet has no liabilities. That is because the banks and bondholders and vendors that create liabilities for ordinary businessmen are partners. And they are like the bulk of the partners in a typical large local or regional accounting firm – virtual employees with a tendency to get a little uppity until slapped around by the managing partner.
The managing partner is at least moderately sociopathic and a dictator of greater or lesser benevolence. He, and it is almost always a “he”, is charged with the responsibility of making sure his partners don’t give away the store to clients and staff. At any rate, the deal is that they get what the managing partner thinks they deserve with enough grease thrown in to stop them from squeaking too much.
It goes without saying that Trump is the managing partner in the enterprise, although he would probably prefer something more reflective of his value, maybe God-Emperor. On the asset side, there is no such thing as accumulated depreciation. That is because an asset under Donald Trump’s umbrella can only go up in value.
Let’s Buy Some Property And Then See How Donald Does It
If you or I were to buy a commercial building for $1,000,000 the entries would be a debit to cash of $200,000 and a credit to equity of $200,000 for the cash we would put in to start things. Then we borrow $800,000 debiting cash and crediting mortgage payable. Next, we close on the building (although it probably all happens simultaneously) debiting land maybe $100,000, building $900,000 and crediting cash $1,000,000, bringing cash back to zero and leaving us with a balance sheet with assets of $1,000,000, liabilities of $800,000 and equity of $200,000.
Now let’s try an acquisition using Trump accounting. A million dollar deal is of course way too small for Trump to get involved in, so we’ll scale it up by a factor of 100. That’s still a small deal for him, but it might merit at least a few minutes of his attention. Trump buys property for $100 million. It goes on his balance sheet at $110 million, if he is feeling conservative. That’s it.
The few million dollars in annual tax depreciation that flow from the acquisition can shelter some of Trump’s actual cash income but have no effect on his very, very great balance sheet.
The Truth In Trump Accounting
There actually is, or at least was, some reality behind Trump accounting. Chase Peterson-Withorn, in this piece, writes about the fading of the Trump premium. In the period in 2015 before he announced his presidential bid, Trump-branded properties on a per-square-foot basis sold at 9% more than similar properties without his imprimatur. In 2016, it was different:
Now researchers say the Trump name offers no pricing advantage at all. Trump-branded condos are no longer selling for notably higher prices and the per-square-foot premium Trump’s name seemed to command is no longer statistically significant.
Ahhhh! What do those researchers know?
I don’t know how well I have explained it, but if I did it at all well, now you know why Donald Trump loves depreciation so much.