> But when taxes are high, I see that as an incentive to hide the profits by investing in the future.
That isn't really the societal win you're making it out to be though. If you "pocket" profits, i.e. pay them to investors, the investors just go out and invest them again in something else. Which is actually better, because it reduces concentration of wealth inside of corporations. Instead of one corporation growing ever larger because they have to invest internally or be subject to punitive taxes, you get many new independent companies being formed as investors seek out new opportunities for the money they receive as dividends.
The other problem is that there are many forms of investment that are taxed differently. Government bond interest typically isn't taxed. Real estate appreciation typically isn't taxed until sale, which means they can be deferred indefinitely. Investing in foreign corporations will be subject to the tax rates in those other countries. So if you increase the domestic corporate tax rate, investment moves from domestic companies to things like real estate speculation and foreign companies, which may not be desirable.
Moreover, multinational corporations arrange for profits to be declared in whichever jurisdiction has the lowest taxes, so increasing the tax rate on domestic corporations disadvantages them against multinationals that won't be paying those taxes.
So if you increase the domestic corporate tax rate, investment moves from domestic companies to things like real estate speculation and foreign companies, which may not be desirable.
The reverse is actually true. Historically, the lower the tax rate, the more investment you get in real estate speculation and other passive income streams because it's now more efficient to simply not invest in productive activities when you can just get effectively free money without doing any work.
The higher the tax rate, the more businesses invest in actual business activities, because they get more expenses they can use to offset income they may earn, and because passive activities generally don't generate enough of a return to be worth the investment compared to (re)investing in an actual business.
> The higher the tax rate, the more businesses invest in actual business activities, because they get more expenses they can use to offset income they may earn
The purchase price of real estate is ultimately deductible as depreciation, as is mortgage interest, and any profits from rents get reinvested into buying more real estate which becomes deductible as depreciation again. Also, real estate speculation is commonly done using LLCs (passthrough, no corporate income tax anyway).
Land doesn't depreciate, only structures and improvements to the land. Mortgage interest is not included in the basis of real property or in depreciation. It's just another deductible expense.
Most real estate companies are partnerships or REITs due to special tax provisions. But most of their investors are corporate entities.
Generally, profits from rent are not reinvested in buying more real estate because they simply aren't sufficient for that. Real estate is a cash flow game: real properties are purchased through commercial mortgages, and rental income services the debt. Generally, profits arise when real properties are sold for appreciated values. Because of this, real estate investment flourishes in low tax years: as a result of depreciation, the cost basis of the real property has been reduced, so the taxable income from the sale has increased.
> Land doesn't depreciate, only structures and improvements to the land.
The structures are generally the majority of the value of the property.
> Mortgage interest is not included in the basis of real property or in depreciation. It's just another deductible expense.
Nonetheless it's a major expense and fully deductible. They also get to deduct property maintenance etc.
> Most real estate companies are partnerships or REITs due to special tax provisions. But most of their investors are corporate entities.
A group of ten individuals who get together to buy an apartment complex are not a corporation. Moreover, if the investors are a corporation, it's still one less layer of indirection -- for a corporate investor, if the real estate holding company were an S Corp you would be paying corporate income tax twice.
> Real estate is a cash flow game: real properties are purchased through commercial mortgages, and rental income services the debt.
This is true until the debt is paid, but then isn't that the point? They get to deduct the interest and depreciation and maintenance, and wipe out their rental income.
> Because of this, real estate investment flourishes in low tax years: as a result of depreciation, the cost basis of the real property has been reduced, so the taxable income from the sale has increased.
That would result in real estate sales in low tax years, i.e. willingness to divest rather than willingness to invest. During the high tax years people would want to buy/hold and continue speculating to continue to defer paying the high taxes on the appreciation.
The structures are generally the majority of the value of the property.
Depends, unless you're talking about very large structures like office buildings, factories, or malls in which case the structures are definitely worth more than the land. For most residential and small-to-midsize commercial plots, it depends on where the land is. In states like HI, CA, NY, and NJ, the land is worth more than the structures on top of it, and that is triply true in cities like LA and SF.
Nonetheless it's a major expense and fully deductible.
Yes, it's generally a real property company's biggest expense. But as far as business expenses go, it's not that big compared to the expenses another business would face. (My real estate clients included a number of REITs, including a major mall chain, and the owners of a number of LA, NY, SF office towers.)
They also get to deduct property maintenance etc.
Generally, no. Under a triple-net lease, they would not get to deduct these costs because they're not paying them. Most commercial properties are leased on a triple-net basis, so the tenant is paying maintenance costs.
A group of ten individuals who get together to buy an apartment complex are not a corporation. Moreover, if the investors are a corporation, it's still one less layer of indirection -- for a corporate investor, if the real estate holding company were an S Corp you would be paying corporate income tax twice.
My statement was directed to the real world, in which most investors in REITs and real estate partnerships are corporate entities, not to a hypothetical situation.
Also, I'm not sure if you are aware of this but an S-Corp does not pay corporate income taxes, so there's only a single layer of tax whether they use an S-Corp, LLC, REIT, or LP, or GP. They're all flow-through entities for tax purposes that are differentiated primarily by their legal/compliance burdens.
This is true until the debt is paid, but then isn't that the point? They get to deduct the interest and depreciation and maintenance, and wipe out their rental income.
Yes, that's the point, but more to the point, that's the entire point of real estate investing. You make your money selling the real estate, but it's a holding game until then; you just care that you make enough in rental income to pay your debt service costs (it's not that you wipe out your rental income with expenses, it's that your expenses are covered by the rental income). This is why property owners can let storefronts remain vacant for years, so long as their rental income from the building is otherwise covering debt service.
That would result in real estate sales in low tax years, i.e. willingness to divest rather than willingness to invest. During the high tax years people would want to buy/hold and continue speculating to continue to defer paying the high taxes on the appreciation.
Right, but the flip side of you divesting is someone else investing, at appreciated costs from you paid.
The exception of course is those real property companies that are not engaged in speculation but are primarily in the business of being landlords. They have actual businesses, and correspondingly tend to spend more on upgrades during periods of higher taxes. (See, e.g., LA's or SF's office markets: prior to the TCJA tax cuts, billions or hundreds of millions spent on improving existing office buildings but since then essentially zilch.)
> Depends, unless you're talking about very large structures like office buildings, factories, or malls in which case the structures are definitely worth more than the land.
Or large apartment complexes. But isn't that where most real estate investing goes? Detached single family homes are mostly owner-occupied.
> Generally, no. Under a triple-net lease, they would not get to deduct these costs because they're not paying them. Most commercial properties are leased on a triple-net basis, so the tenant is paying maintenance costs.
But then the tenant is paying correspondingly less rent, which means less taxable income to the property owner. It's a wash either way.
> Also, I'm not sure if you are aware of this but an S-Corp does not pay corporate income taxes
You're right, I meant C-Corp.
My point being that if the investor is a "corporation" in the sense that it's paying corporate income tax itself, that has little to do with the thing it's investing in. If it buys ownership of a REIT and the REIT itself doesn't pay corporate income tax, and the corporate tax rate is high, that's more advantageous than the same corporate investor buying shares of Union Pacific, whether or not the entity doing the investing then pays corporate income tax on the income it receives from the investment.
> Yes, that's the point, but more to the point, that's the entire point of real estate investing.
It's one of the two options. Option one, you zero out your taxable income while building equity, and then sell to liquidate. Option two, you zero out your taxable income while building equity, then once the loan is paid off you get to keep the rental income, which can be used as down payment on additional properties if you prefer to invest further rather than pay the tax and spend the money.
> Right, but the flip side of you divesting is someone else investing, at appreciated costs from you paid.
The point being that high turnover during periods of low taxation isn't a result of people wanting to get into the real estate market, it's a result of people wanting to get out. So it tends to cause housing to become more affordable rather than inflating a bubble because people hold who would rather sell if not for selling incurring a major tax bill.
> They have actual businesses, and correspondingly tend to spend more on upgrades during periods of higher taxes.
That's evidence of what I'm saying -- when corporate taxes are high, people move investment from businesses to real estate. Making improvements to real estate is investing in real estate. Lower taxes and they stop because they make more to invest the same money in other businesses.
Or large apartment complexes. But isn't that where most real estate investing goes? Detached single family homes are mostly owner-occupied.
In terms of absolute deals? Yes. In terms of dollar value? Not even close, commercial property far exceeds residential property.
But then the tenant is paying correspondingly less rent, which means less taxable income to the property owner. It's a wash either way.
Generally, no. That's not how triple-net leases work. Tenant pays market value, and maintenance costs on top of that.
It's one of the two options.
In your hypothetical, sure. But in the real world, you don't make enough money in rent from one property to use to pay a down payment on the other, and actual real estate investment companies don't pay down the loans; they take out balloon mortgages and just pay interest on the loans until they sell (or refinance before the balloon). I've done this for enough real property investor clients to know how they actually think.
That's evidence of what I'm saying -- when corporate taxes are high, people move investment from businesses to real estate. Making improvements to real estate is investing in real estate. Lower taxes and they stop because they make more to invest the same money in other businesses.
No, it's not. Because all businesses make more investments in their businesses during periods of high taxes. And specifically in my example, I wasn't referring to real estate investors, but companies that actually manage buildings with the intent of being landlords and making their money from commercial leases, not from selling their buildings.
Yes. The op assumes that malinvestment / inefficient use of capital is not a thing.
You can only invest so much into a grocery store. The entire point of us having free markets is so that capital can move around. Locking it down into once place is the exact opposite of what you want to do.
That isn't really the societal win you're making it out to be though. If you "pocket" profits, i.e. pay them to investors, the investors just go out and invest them again in something else. Which is actually better, because it reduces concentration of wealth inside of corporations. Instead of one corporation growing ever larger because they have to invest internally or be subject to punitive taxes, you get many new independent companies being formed as investors seek out new opportunities for the money they receive as dividends.
The other problem is that there are many forms of investment that are taxed differently. Government bond interest typically isn't taxed. Real estate appreciation typically isn't taxed until sale, which means they can be deferred indefinitely. Investing in foreign corporations will be subject to the tax rates in those other countries. So if you increase the domestic corporate tax rate, investment moves from domestic companies to things like real estate speculation and foreign companies, which may not be desirable.
Moreover, multinational corporations arrange for profits to be declared in whichever jurisdiction has the lowest taxes, so increasing the tax rate on domestic corporations disadvantages them against multinationals that won't be paying those taxes.