Pass-Throughs

First, the Slumlords do not own Dilapadia in their own names. Instead, their accountant and attorney have set them up with a limited liability corporation, LLC, which holds the title to Dilapadia. This is the norm, with the ownership of most multifamily real estate structured as an LLC, partnership, or “S” corporation. Those arrangements provide the Slumlords with the benefits of corporate protection, meaning they usually cannot be held personally responsible for the business’s debts. Yet the arrangements also allow the rental income from the entity to “pass through” to the Slumlords or other beneficiaries personally, without any assessment of the corporate income tax that is charged against other forms of corporations. A true “have your cake and eat it too” deal, courtesy of United States tax laws.

Avoiding both corporate tax and personal liability is already a huge gift our government gives to the Slumlords. But the gifts keep on coming, because the Slumlords are also allowed to deduct 20 percent of Dilapadia’s pass-through income each year. Similar pass-through benefits are provided to Real Estate Investment Trusts, REITS, which distribute their income to shareholders. Huge hedge funds and private equity firms like Blackstone have exploited these loopholes to create REITS that now own over a million US rental units, including an increasing number of single-family homes.¹⁷

The pass-through income deduction is estimated to provide $50 billion worth of benefits each year, almost solely to the richest among us.¹⁸ Alex Schwartz, author of the seminal book Housing Policy in the United States, calls these benefits “tax expenditures”: while the government does not write a check to the Slumlords, the government gives them the same value by sacrificing money that otherwise the Slumlords would owe in taxes.¹⁹ According to the Congressional Joint Committee on Taxation, over 60 percent of the pass-through deduction’s benefits go to the top 1 percent wealthiest Americans.²⁰

Let us look at Tammy Tenant, who lives at Dilapadia, or Maggie Manager, who works there. Tammy and Maggie get no such break on the taxes they pay on the income they earn from their hard work. But the Slumlords get these benefits on their “passive income”: money they make just for sitting around as owners. The former chief of staff of the Joint Committee on Taxation, Edward Kleinbard, calls the pass-through deduction the “worst tax idea ever… . It simply excuses the affluent from taxes imposed on the rest of us.”²¹

Depreciation and Tycoon Love

“I love depreciation,” Donald Trump admitted during a 2016 presidential debate.²² No wonder. It is one of the most impactful tax breaks that Trump and other real estate tycoons receive. Trump’s fellow real estate tycoon Geoffrey Palmer attributes his three decades of tax avoidance to “the magic of depreciation.”²³

It is a magic trick that benefits the Slumlords as well. On top of the 20 percent pass-through deduction they receive, they also get to deduct the $10 million cost of Dilapadia in proportional amounts over the course of 27.5 years. That is the period during which the law says a multifamily residential building depreciates down to zero value. So the Slumlords get to take an automatic $362,000 deduction from their taxable income each year.

They also get to deduct the cost of doing business, like the fees paid to the accountants and lawyers that set up their LLC, Maggie Manager’s and others’ salaries, maintenance costs, etc. And they can depreciate the cost of capital improvements to Dilapadia, such as a new roof.

Of course, despite the IRS deduction formula, Dilapadia’s value after twenty-seven years is clearly not zero. In fact, Dilapadia’s worth is likely to have increased a great deal, since that has been the case for most multifamily housing in the US.²⁴ So, if they sell Dilapadia, the Slumlords would in theory owe taxes on the difference between the sale price and the depreciated value. This is called “recapture” of the depreciation benefits provided over the years: if the Slumlords sell for $20 million and they have taken all their depreciation, the “recapture” would mean they owe taxes on all of that $20 million. But, spoiler alert: our tax laws have provided the Slumlords with paths to avoid this recapture, too.

Capital Gains and “Voluntary” Taxes

Both the increase in the value of Dilapadia and the pass-through income from it are classified as capital gains. Wealthy people like the Slumlords make most of their income through sources like capital gains and other forms of pass-throughs.²⁵ By contrast, most working people never see much capital gains in our bank accounts: nearly 70 percent of capital gains in the US are received by the wealthiest 1 percent.²⁶

Our tax laws provide these wealthy few with a breathtaking array of benefits on their capital gains income. First, their investment income is taxed at a lower rate than the equivalent amount of employment income, again rewarding the Slumlords for making money passively—while penalizing Tammy and Maggie for earning their money via hard work.²⁷ Second, capital gains from the increase in Dilapadia’s value are not taxed when they occur: the Slumlords pay taxes on their gains only if they sell the property. That means there is a huge amount of untaxed wealth sitting around in this country. Capital gains that have not yet been taxed make up over one-third of the assets of the wealthiest 1 percent of US households.²⁸

So the Slumlords have the luxury of choosing an opportune time to sell. For example, they can sell during a year when they have capital losses to offset the gains, thus reducing or even eliminating any tax bill. Those of us who pay taxes on our working income are not so fortunate. Consider the IRS’s reaction if Tammy or Maggie—or you or I—announced, “I choose to delay paying my payroll taxes for the foreseeable future, thank you very much.”

Finally, and best of all for the Slumlords, there are easy ways to not just delay paying capital gains taxes, but to avoid them altogether. So easy, in fact, that the Center on Budget and Policy Priorities calls capital gains taxes “effectively voluntary.”²⁹ We will review some of the paths to capital gains tax avoidance.

Buy, Borrow, Die: Tax-Free Cash to Spend

We know that Dilapadia likely increases in value even as the Slumlords get to claim depreciation deductions each year. But, since they are not selling Dilapadia, that increased value is just a paper figure that provides no immediate benefit to the Slumlords. Right? Wrong. Not only can the Slumlords borrow money against Dilapadia’s increased worth, but the loan proceeds are not counted as taxable income. The Slumlords even get to deduct the costs of securing that loan, plus the interest they pay on it.

Real estate pros call this “the harvest.” It is stage two of the real estate tax avoidance strategy known as “Buy, Borrow, Die.”³⁰ (More about the final-act “Die” stage three later.)

One real estate tax adviser who enthusiastically touts the benefits of this cash-by-borrowing approach admits the quiet part out loud: Tammy Tenant will foot the bill for the Slumlords. “Over time, your tenants pay the loan off for you. You get to keep the property, which hopefully keeps appreciating for you, and the rents rise with time, even as your mortgage payment remains fixed,” writes the DPW Certified Public Accountants firm. “And when you pay off the loan in full, guess what? You can turn around and do it all over again, borrowing more cash against your property and letting your tenants pay that loan off, too.”³¹

As a longtime real estate joke has it, “I must be rich, because I owe millions.” What is not so humorous for the rest of us is that those millions owed can and do pay for lavish lifestyles for landlords, funded by their tenants and other taxpayers.³²

Home Cooking with State and Local Tax Breaks and Funding

Maggie Manager purchased a two-bedroom bungalow a few years ago. Each year, she receives a bill for property taxes she owes. Those taxes, which help pay for local schools, public safety, and road maintenance, are based on the value of Maggie’s home. But her wealthy bosses may pay a lower rate for those same property taxes.

The Slumlords’ property tax bill for Dilapadia may be reduced by abatements or PILOTs (payments in lieu of taxes) provided by local government in return for promising to develop or improve property. For example, the City of New York’s 421a program gave $1.7 billion per year in tax abatements to developers and owners, more than the city spent on low-income housing.³³ Another example: the massive REIT Mid-America Apartment Community, whose one-hundred-thousand-plus units make it one of the largest landlords in the nation, received $3.8 million in tax-increment financing (TIF) subsidies for projects in Texas.³⁴ The Lincoln Institute for Land Policy estimates that property tax incentives for businesses cost local governments as much as $10 billion each year.³⁵

Why are the Slumlords so extremely successful in negotiating down their local tax obligations and wrangling subsidies from state and local governments? Because they can and do hire the best lobbyists and attorneys to advocate for them—and then deduct those professionals’ bills from their tax obligations. Poor Maggie cannot compete with that. But, hey, someone needs to pay for the fire trucks, right?

Being Rich and Owning a Home

The Slumlords own two homes, a mansion in Poshville and a beach house on Sandy Acres. Being homeowners qualifies them for tax breaks that their Dilapadia renters like Tammy Tenant do not receive. The Slumlords can claim a deduction on the mortgage interest they pay on both homes on loans that total up to $750,000. They can deduct the property taxes they pay up to $10,000, and they can sell the homes without paying capital gains on amounts up to a half-million dollars. Together, these tax breaks benefit homeowners more than $30 billion each year.³⁶ Government homeownership subsidies are a big contributor to the startling fact that the richest American families rake in nearly 40 percent more in government benefits each year than the poorest families.³⁷

That contrast is alarming, but calling out homeownership subsidies can be a tricky business in the United States. Intertwined with this government largesse are powerful cultural and marketing forces that elevate homeownership: nearly three-quarters of Americans say owning a home is a higher measure of achievement than having a successful career, raising a family, or earning a college degree.³⁸

As Alex Schwartz writes, “Regardless of political affiliation, race, ethnicity, or class, virtually all Americans regard homeownership very positively. Not owning a home is unimaginable to countless homeowners and achieving homeownership is a vital goal for many renters… . Homeownership is widely considered essential to achieving the ‘American Dream.’”³⁹

As we saw in chapter 3, beginning with the New Deal, our government began heavily subsidizing home purchases—for white people, at least.⁴⁰ The Trump-pushed 2017 tax reform made mortgage interest and property tax deductions largely benefits taken by the wealthiest only. But the exemption of up to $500,000 tax-free income for married couples selling their home is still a huge benefit to homeowners across income brackets.⁴¹ With the average US home gaining almost $150,000 in value over the past ten years, it is understandable that most Americans see homeownership as a no-brainer financial investment.⁴²

Homeownership provides other benefits, too. Schwartz’s analysis and ongoing survey data show the same thing we see with our renter clients: nearly all of them would prefer the stability and autonomy of owning the roof over their heads.⁴³ And for good reason, given that so many of their landlords have refused to make basic repairs, retaliate when the tenants complain, and force displacement by refusing to renew leases for arbitrary reasons.

So, whenever I criticize government support for homeownership, our clients’ desire to own their own homes gives me pause. Would stopping the subsidies now be like pulling up the ladder to economic and housing security, right after multiple generations of white people have safely scaled the top rung? After all, as discussed in chapter 3 and chronicled in Richard Rothstein’s Color of Law and elsewhere, the US white middle class was created in significant part by government-subsidized home purchases that were largely off-limits to Blacks and other persons of color.⁴⁴

As we have seen, those racist housing policies are a big reason why there is such a startling contrast in Census data on wealth by race.⁴⁵ With most US households holding a majority of our wealth in our home, Black households have on average just $9,567 in net worth, compared to white households that enjoy an average net worth of $171,700.⁴⁶ Rather than cutting off the flow of homeowner benefits, perhaps we should beef up enforcement of the Fair Housing Act? Perhaps we should pursue housing reparations or other race-conscious funding programs so that Blacks can finally get the same homeownership boost we have already handed to white households?⁴⁷

The problem with this approach is that even our generous government subsidies do not ensure that homeownership benefits everyone. For several reasons, including racist home valuation practices, the Black-white wealth discrepancy does not get erased when Black households own their homes. Even when factors like schools, commute times, and crime rates are factored in, homes in Black-majority neighborhoods are worth much less than comparable homes in white-majority neighborhoods.⁴⁸ And Black home purchasers were the biggest casualties of the mortgage abuses of the early 2000s and the foreclosures that followed.⁴⁹

We saw in chapter 3 that Keeanga-Yamahtta Taylor, author of Race for Profit, calls the abuses that use the powerful lure of homeownership “predatory inclusion.”⁵⁰ These schemes are more American nightmare than dream, even after the foreclosure crisis led to tightened mortgage regulations. In our clinic, we still see low- and middle-income renters who are being exploited by rent-to-own arrangements. We also see mobile home purchases where, as we discussed in chapter 1, the requirement of leasing the land where the home is situated can be disastrous for the homeowners.⁵¹

The elevation of homeownership hurts society more broadly, too. For the disproportionately white households that do benefit financially from homeownership, their fiscal reliance on the value of their homes too often motivates toxic behavior. Racial discrimination in home lending and sales was driven not just by governments and lenders; it was fueled in significant part by white homeowners fearing the loss of their nest egg because of integration. Those same forces still motivate aggressive NIMBY (not in my back yard) resistance to affordable housing across the country.⁵² As historian Rick Perlstein has written, “A home-owning American working class … [behaves] like a bourgeoisie—more interested in preserving home values than extending the circle of social solidarity… . A social democracy that depended on homeownership was always a social democracy poised to swallow itself.”⁵³

In a nation with limited public pensions and a tattered safety net, individuals’ and families’ laser focus on preserving home value is quite predictable. Since homeownership is by far the top source of US family wealth, Canadian writer Dan Darrah says that our houses provide a “fig leaf” that covers for our lack of universal social and economic rights. “Neoliberal governments have been happy to let the home function not just as a place to live but also a retirement plan,” he writes.⁵⁴

But that fig leaf is too small to obscure the inequities in the US economy—even in housing. In theory, since Maggie Manager owns her own home, she can benefit from these tax breaks, too. But, like most people with incomes below $200,000, she is unlikely to claim itemized deductions. That means most of the benefits of the mortgage interest and property tax deductions are enjoyed by the wealthiest 20 percent of households.⁵⁵

Other nations have shown that it is possible to deemphasize homeownership while achieving universal housing access.⁵⁶ “We’ve very much been brainwashed into thinking that homeownership provides stability that rentership can’t,” says Jenny Schuetz of the Brookings Institution. “[But] we could create that sort of long-term stability of payment for renters, which would allow them to stay in neighborhoods for longer and to put down roots and be part of the community without being pushed out by financial circumstances.”⁵⁷

Instead, as Schuetz and other housing experts have concluded, our current mortgage interest deduction does not effectively incentivize homeownership, especially for first-time home buyers. Instead, it only encourages already wealthy people like the Slumlords to buy more expensive homes.⁵⁸

Zones of Opportunity—for the Rich

The 2017 Tax Cuts and Jobs Act (TCJA) was a bonanza for landlords. Besides preserving previous real estate tax breaks like depreciation and pass-throughs, the TCJA gifted real estate investors with a new path to avoiding capital gains taxes: opportunity zones.

The pitch for the opportunity zones scheme sounds great. It encourages investors like the Slumlords to take capital gains earned from the sale of property like Dilapadia and invest them in areas where the community has significant needs for development. Senator Tim Scott of South Carolina, who promoted the legislation, claims the program “provides needy communities with a new tool and a level playing field when competing for investment… . Opportunity Zones are already credited with spurring economic development, job creation, revitalization, and new opportunities for countless Americans.”⁵⁹

Under this scheme, the tax breaks for the Slumlords are enormous: if they keep their investments in the zones in place for ten years, they get a permanent exemption from all the capital gains they make on those investments. Even if they hold the investment for a shorter time, they still get tax deferrals or reductions. The Joint Committee on Taxation estimates that opportunity zones will cut these investors’ tax burdens by $3.5 billion a year.⁶⁰

But this is not government money well spent. The definition of what areas count as opportunity zones is far too broad, and the guidelines for who benefits from the investments are far too loose. Not-so-low-income areas can receive opportunity zone–qualifying investments. Even investments in truly low-income areas may be subsidizing gentrification rather than helping the current residents in need. Investigations into the opportunity zones scheme have revealed that untaxed money is invested in expensive hotels and high-rent apartment buildings, student housing at elite universities, and even luxury condominiums at a superyacht marina.⁶¹

This program provides attractive tax-avoidance options for the Slumlords but not much benefit to those in need. As Samantha Jacoby of the Center on Budget and Policy Priorities has written in her analysis of opportunity zones, “The direct tax benefits of opportunity zones will flow overwhelmingly to wealthy investors, but the tax break might not do much to help low-income communities, and it could even harm some current residents of such communities.”⁶²

Like-Kind of a Scam—1031 Exchanges

The 2017 tax law was not all good news for rich people. It closed a loophole that had allowed individuals and firms to avoid taxes on the sale of assets by using the sale proceeds to buy something similar, such as selling one antique car and buying another. But when shutting off this practice, the TCJA preserved a single form of this “like-kind,” or 1031, exchange. You guessed it: real estate.

That means the Slumlords can still sell Dilapadia for a net profit and pay zero taxes on that profit. They just need to use that sale money to buy another piece of real estate, say Dilapadia II, within six months. These exchanges can go on indefinitely, all while the Slumlords take out loans against the properties’ value to assure them a generous cash flow.

Those like-kind exchange delays mean the deferral of taxes owed—often on tens of millions of dollars in gained value—goes on indefinitely, too. These like-kind swaps benefit real estate investors—and cost taxpayers—in an amount estimated to be $10 billion each year.⁶³

Not Avoiding Death but Still Avoiding Taxes: Stepped-Up Basis and Estate Tax Exemptions

The Slumlords can delay paying taxes indefinitely. But, alas, they cannot live forever. When they die, the government will finally collect their long-deferred taxes on their real estate gains, right?

Nope. Stage three of the “Buy, Borrow, Die” tax-avoidance strategy kicks in.

Let’s say Dilapadia doubled in value from $10 million to $20 million during the Slumlords’ ownership, a predictable increase in worth for multifamily housing.⁶⁴ Remember that they avoided paying any taxes on that increase in value, since the assessment of those capital gains taxes does not occur until a sale happens. Now, as it turns out, the Slumlords’ capital gains died with them, thanks to the “stepped-up basis” tax break.

For estate tax purposes, the value of Dilapadia is “stepped up” to its worth at the time of the Slumlords’ deaths. All the capital gains accrued during their lifetime are wiped out, so the estate does not owe any taxes on them. They disappear, never to be taxed. The stepped-up basis rule on capital gains benefits wealthy heirs in an amount as much as $53 billion each year.⁶⁵

Combined with the huge federal estate tax exemption of nearly $26 million for a couple like the Slumlords, the Slumlord heirs will take over full benefits of Dilapadia without paying a penny of tax. This may seem outrageous, but it happens quite often: less than one-tenth of 1 percent of estates owe any federal tax at all.⁶⁶

With all these breaks to wealthy heirs, it should come as no surprise that as much as 60 percent of all wealth in the US is inherited.⁶⁷ Much of those unearned riches come in the form of tax-protected real estate. While Tammy Tenant and Maggie Manager pay taxes on the money they earn with their hard labor, the Slumlords avoided taxes during their lifetime. And the Slumlord Juniors will become rich the old-fashioned way: they will inherit it. As Justin Miller, national wealth strategist at the investment banking company BNY Mellon, told the New York Times for a 2019 article on real estate tax breaks, “You’re almost allowing the creation of a royal class of families.”⁶⁸

How We Fix This

The Center on Budget and Policy Priorities flatly states, “Much of the income of the well-off never appears on their tax returns.”⁶⁹ It is no wonder that the wealth of billionaires has skyrocketed even while evictions and emergency shelter requests are rising.⁷⁰

But these landlord tax breaks are the result of political choices, and those choices can be reconsidered. Along with the Center on Budget and Policy Priorities (which graciously provided advice for this chapter) and Patriotic Millionaires (whose terrific book, Tax the Rich! How Lies, Loopholes, and Lobbyists Make the Rich Even Richer, was cowritten by my wonderful son Sam Quigley), the Economic Policy Institute and others have long called for the repeal or major restructuring of the loopholes we have discussed here.⁷¹ They call for the elimination or vast reductions in pass-through deductions, opportunity zones, stepped-up basis, like-kind exchanges, and estate tax exemptions. US Senate Finance Committee chair Ron Wyden has proposed a billionaires income tax to terminate many of the tax avoidance schemes that benefit wealthy investors.⁷²

Beyond cutting back on tax breaks for wealthy landlords, advocates at the national and local levels like People’s Action and Center for Popular Democracy push to switch our approach completely: use tax policy to deter toxic real estate investor behavior and raise funds for affordable housing.

Among their proposals are to impose extra taxes on investors who buy housing not for much-needed shelter but instead for speculation or tax-avoidance purposes.⁷³ Wealthy investors are known to buy condominiums to sit empty, operating as so-called “safe deposit boxes in the sky.” The result is some cities have more vacant units than they do unhoused persons.⁷⁴ Nationally, there are twenty-eight vacant homes for every one person experiencing homelessness.⁷⁵

We can address this by imposing a hefty charge on profits made from selling a home without making any capital improvements. A flipping tax can charge for quick turnarounds by home purchasers. Blight/vacancy taxes and taxes on high-dollar real estate transactions are possible, too. They were among the popular proposals that won approval from voters in the November 2022 elections, including a “mansion tax” Los Angeles voters imposed on high-dollar transactions.⁷⁶

At the federal level, multiple members of Congress have introduced legislation like the Stop Wall Street Landlords Act and the Stop Predatory Investing Act.⁷⁷ This legislation would block wealthy investors from claiming some deductions on their ownership of single-family homes, impose a transfer tax on their purchase of single-family homes they are buying solely for investment purposes, and incentivize the investors to sell the homes back to community members. We will see in chapter 9 that housing success stories like Vienna’s were built on tax policies like these, including significant taxes on luxury goods and unused land, along with overall progressive tax rates that demanded greater contributions from the wealthy.⁷⁸

In tax policy, we get the behavior we reward. Do we want to have a housing policy that helps our client Robert instead of real estate billionaires? Do we want to see housing as a fully realized human right for all instead of a tool for windfall profits for a select few? If so, we must fix the tax policies that got us here.