How Not to Pay Taxes: Lessons from the L.A. Dodgers' Owners
That's what the owners of the L.A. Dodgers, the famously feuding Frank and Jamie McCourt, did. The secret comes down to owning commercial real estate, rental property, or another qualifying business property that you can use to offset your income.
From 2004 through 2009, The McCourts pocketed income totaling $108 million without paying any federal or state taxes, according to a 1,423-page document Jamie McCourt filed in the couple's divorce case. (If you're not familiar with the power couple's ugly divorce, read the Cliff Notes version from the Business Insider.)
The court papers indicate that the McCourts deliberately structured their real estate business -- mostly commercial real estate -- to allow them to live tax-free, legally, by claiming enormous tax losses, reported the L.A. Times. And now they're fighting each other, in part, to keep those lucrative write-offs.
The most infuriating part is it's all legal. But you, too can take advantage of this tax law if you own any property for business purposes. The McCourts, with an estimated net worth of $1.2 billion, made the bulk of their wealth in real estate before they bought the Dodgers in 2004. Even though you may never own your own baseball team, you can still take some pointers from the McCourts. Here are, we gather, some of their favorite insights into the tax code:
Business property losses are allowed by law to be written off in a way that offsets your income, year after year, until they net out. It is basically an allowance for the wear and tear, deterioration, or obsolescence of the property.
This reasoning behind the rule is that generally, you cannot deduct in one year the entire cost of property you purchased for business use, so you depreciate it -- that is, you spread the cost over a number of years, and deduct a part of the cost each year.
In the McCourts' case, Jamie claims that, in 2008, the net loss carry-forward from previous years for them was $109 million -- thus, only a fraction of what they actually spent purchasing property. Also a net loss of this size means the McCourts could have earned as much as $109 million without paying a penny of income tax since they were depreciating that much across their various holdings.
The loss carry-forward for the McCourts had increased to $135 million in 2008, which makes it sound as if 2008 was one horrible year, the LA times reported. Yet according to another document Jamie filed in court, one of Frank's partnerships paid him $23 million that year. But apparently, they had acquired additional property and were now depreciating its costs as well.
Let's look at this in more reader-friendly terms.
You can depreciate most types of tangible property, such as buildings (as well as machinery, equipment, vehicles, and furniture) -- you cannot depreciate land, but more on that later. You also cannot claim depreciation on property held for personal purposes. So if you purchased a duplex and rented out one unit to a tenant and used the other for your office, you can depreciate the purchase cost of the building, and you can depreciate the office furniture, copier, etc. But if you purchased it as your primary residence and moved your mother-in-law into the other unit, rent free so she can babysit your kids after school, you cannot depreciate the purchase cost.
You must stop depreciating property when the total of your yearly depreciation deductions equals your cost or other basis of your property.
You may depreciate property that meets all five of the following IRS tests.
- It must be property you own. You own it if you hold the legal title. You also, however, are considered the owner even if you have a mortgage. This also applies if you assumed the previous owner's mortgage when you purchased rental property.
- It must be used in a business or other income-producing activity, such as commercial property or a rental unit.
- It must have a determinable useful life. But you cannot depreciate the cost of land because land does not wear out, become obsolete, or get used up.
- It must be expected to last more than one year.
- It must not be excepted property, as defined in IRS Publication 946, "How to Depreciate Property." Excepted property includes certain intangible property, certain term interests, and property placed in service and disposed of in the same year. So, if you buy a house and flip it three months later in the same tax year, you can't claim depreciation.
And this is why things are extra dicey for the McCourts, who are battling it out like "War of the Roses." Who gets what property in this divorce may determine who gets to continue forgoing paying Uncle Sam -- and who may have a large, overdue tax bill once the game's over.
Sheree R. Curry is an award-winning business journalist who resides in a Minneapolis suburb.