[Dead Spin] How (And Why) An NBA Team Makes A $7M Profit Look Like a $28M Loss

And they are wrong. If I buy a house, via financing, for $200 and my monthly payments are $10 and my monthly income is $10.50 then technically I have made $6 for the year, at 50 cents per month (let's just assume there are no other expenses). I have $6. I have income. I have made $$. I can do whatever I want with that money. But the key is I have made $$.

If I depreciate that property at 27.5 years then I can depreciate $7 per year (rounding down). This gives me a loss of $1 for the year, for tax purposes. The IRS allows this to spur investment (not for accounting reasons). But have I really lost $1? No!! I made $6.

It's not that complex. Income vs taxable income. There is a difference. If I come to you telling you I am losing $$ on my rent house every year because I am taking a depreciation expense for tax reasons then you will laugh at me and say, dude you made $6. Then you may give me congrats on making $6 and keeping the whole thing, instead of the IRS getting a piece. If I'm seeking additional financing for something else I'm not going to a bank saying I'm losing $1 every year on my rent house. I'm telling the bank I made $6. I'm using a non-cash expense to turn a profit into a loss. The profit is real, since I'm walking around with $$ in my pocket. The loss is bull****, since I'm walking around with $$ in my pocket. If I have to say, pay child support, you better believe that $6 is gonna be considered $$ made and the court will laugh at me talking about I lost $1 instead of making $6. Now if you want to say I am "correctly booking that loss", then that is accurate...for tax purposes. But at the end of the day I have $6 in my pocket, right? If I have $6, where is my real loss (not the paper one)?

That is a very basic, basic example of something that is allowed to make a profit look like a loss. I don't know enough about these contracts that the owners get to depreciate or whatever, but if I were an accountant working for the players and teams were using expenses like that to create losses then I would advise them to toss that garbage out so we could see the real picture.

 

This isn't true. I can buy a house with a hard money loan and never touch the principal balance. Not the wisest thing to do, unless I plan on getting in and out real quick (kinda like in my example).

The proceeds aren't taxable if I roll them into another real estate investment. And as far as having no basis in the asset, let's just say I depreciate most of it but not 100% (i.e. more than 1 yr at 27.5 years), then what? I have still used excess depreciation to increase my loss (that's the point I was trying to make).

You can avoid tax on the proceeds via a 1031 exchange.

http://www.1031exchangemadesimple.com/

Actually it does.

 

And again you're wrong.

You seem fixated on profit, as if it is the ultimate measure of return on investment. And therefore trying to continually equate profit with cash flow. Which, as many people have told you, repeatedly, is inherently wrong.

In your example - still fixated on real estate and depreciation for some reason, the loss is a real loss. The depreciation represents a real, if non-cash expense. As has been noted there are all kinds of non cash revenues and expenses that could be booked. The owner could lease out the property and the. Use straight line lease accounting, and there are periods where landlord books revenue that on a cash basis he didn't actually collect.

Profit is only one measure to determine whether a company, entity, investment is successful. But to get a picture of matched revenue and expenses - ie profit - for a particular period, the income statement (with all it's non cash entries) is still 100% accurate.

 

Firstly, section 1031 is like-kind exchange. You dont avoid taxes doing a like kind exchange. Best case scenario is you are able to defer the gain. Nontaxable and tax deferred are two vastly different concepts with different implications on tax liability. This deferral is done by reducing the basis in the property received which reduces the depreciation you're allowed to claim over the life of property. This in turn creates the same net tax liability. You end up paying the taxes on that gain either way.

You can't "roll over" proceeds in a straight sell and purchase. The only way to "roll over" is a like kind exchange. But even in like kind exchanges you have to recognize the gain. Ultimately, through reduction in the depreciable basis, the entire tax liability for the gain you deferred is recovered over the depreciable life of the new property you received.

Regarding the nonfully depreciated asset: it still works out the same. Depreciation is a reduction in basis, so when you sell the property you will incur taxable gains if the selling price exceeds your adjusted basis (original cost - accumulated depreciation).

 

You and I are talking in different languages, and I'm not disagreeing with you. Yes, it's a real PAPER loss as far as accounting goes. Yes, it's a valid PAPER loss. But in reality, I haven't "lost" $$ because I have the money in my pocket. Am I short $1 or am I up $6? In real life, not on paper? I'm not walking around saying my business is losing $$. And that has nothing to do with matching revenue and expenses for a certain period or proper accounting (since everyone doesn't have to use proper accounting), because if I am accelerating depreciation then I'm ignoring that principle by brginging another period of expenses into the current one (which is allowed).

Edit: My example is still fixated on real estate depreciation because it's the example that I used to note how one can turn a real profit into a paper loss, similar to what these owners "appear" to be doing by depreciating contracts (I say appear because I don't know enough about what they are doing exactly). That's my only point. I'm not trying to say profit is the only measure of ROI or anything else like that.

 

The gain is deferred, IF I sell my other property (the one I have made an exchange for). So....what if I don't sell that property? Then when do I pay those gains?

 

If you've fully depreciated it, then when you sell it, you have a huge gain on the property which basically "un-depreciates" it. So you end up showing a big loss in the first year and a big gain in the next. Let's say, in your example, you bought $100k item, paid only $10k in interest, and then sold the item the next year for $100k and paid back your loan.

Your net expense is $10k in interest.
In Yr 1, you show $100k depreciation expense and $10k interest expense = $110k.
In Yr 2, you'll show a $100k gain ($100k earned on an asset with an accounting worth of $0 since you depreciated it).

Net, you have $110k loss and $100k gain = $10k loss. Which is exactly what your cash interest expenditure was.

Again, all it does it move around when you're showing the profits vs losses, but at the end, you're not creating any additional artificial loss. Depreciation is not a way to create additional deductions.

No - all you did is change when things are accounted for.

 

The article has already been corrected to say they were totally wrong and the owners aren't doing anything of the sort. They aren't doing it because they can't.

 

No. The gain is deferred always. The gain is used to reduce your basis in the property you acquired. This in turn reduces the maximum depreciation expense you can claim over the usable life. This in effect disallows expenses equivalent to the gain. The lost depreciation means you have more tax liability which over time equals the tax liability of the gain if you had to pay tax on it up front.

 

So doesn't changing when things are accounting for give me the ability to choose when I want to turn a profit into a loss, for a certain period? If your point is that I'm going to catch up in a future year then I completely agree, but that doesn't rebut my point that I can use excess depreciation to flip income to a loss now, right? Or in some situations permanently (i.e. fully depreciating something to claim a loss, cashing out and reinvesting).

Oh, and I disagree on the "artificial" loss part. I have a valid paper loss. I have actually made $$ though. That is an artificial loss to me. How is it now one to you?

 

When do I pay tax on this gain that is deferred always if I don't sell the property?

 

Sure - I stated that from the beginning. But you were arguing that you can double your losses:

Well real estate tax law allows you to double deduct each $ spent up to a point.

It is a seperate expense but you are still essentially getting two deductions from the same transaction.

No, you are essentially double dipping.

Now this changes if you don't finance the real estate, but if you do you are essentially getting 2 deductions for shelling out $$ one time (double deduction for 1 transaction).

None of this is accurate. You don't get two deductions from it. For each $1 you spend, you get a maximum of $1 in deductions, regardless of which period you account for things.

There's no ability to make it permanent. At some point or other, your accounting will reflect reality.

Because in that scenario, somewhere else you had a paper gain and actually lost money to balance it out. In the end of the day, you're just moving when you account for things around, but it doesn't change reality and doesn't create fake losses in long haul. And when you look at someone's books, you can see all that because you see cash flows vs income statements vs balance sheets.

 

You are talking cash flow, rather than accounting. In your example, you say the depreciation makes it a loss, but you've deducted your principal payments, which makes you very wrong in your example.

Cash Flows and Income are an entirely different thing. I'll change your example and say you are getting $9 in income, your payments are $10 ($5 in interest) and $1 depreciation.

Cash Flows = ($1)
Income = $3

Depreciation doesn't exist for tax purposes. They offer you bonus depreciation and 179 deduction to spur investment.

We can't discuss cash flows because we don't know what they are in this case.

 

I'm not talking accounting, period. If I state that you can use depreciation to make a real profit look like a real loss, and someone else starts spitting out GAAP, which I then say most of the dudes I'm referencing aren't even using....then it's clear that I'm not talking accounting. I agree with you that accounting wise a valid loss exists. My original point listed an example to show how you can make it look like you lost $$ when you really didn't, via depreciation. Please stop applying accounting rules to situations where they may not occur. If I'm a dude with 2 rent houses odds are I'm not using debits and credits, right?

My simple example listed the monthly cash flows, which were 50 cents. My income is 50 cents a month, or $6 for the year. My only cash expense is my mortgage ($10 a month). My rental income is $10.50 a month. I have no other income or cash expenses. Therefore I know what my cash flow is....50 cents a month. I have made $6 of income, that is cash in my pocket. Do you agree or disagree? Now if I take a non-cash deprectaion expense of $7 for the year ($200/27.5) then I have lost $1 on paper. Do you agree or disagree. But at the end of the day, I made $6? Do you agree or disagree? Which is a more accurate statement....saying I lost $1 or that I made $6? Which is tangible, the $1 paper loss or the $6 in my pocket? Which does everyone besides the IRS (who is offering me this break to spur investment) care about, the $1 paper loss or the $6 in my pocket? If I go to a bank seeking financing which position will I take? If I want you to go into business with me which position will I take? If I get a divorce which position will my wifes lawyer take when they look at how much $$ I have? If child support comes after me will they think I have $6? Etc.

Accounting wise the $1 loss is "valid". But in the real world that $1 loss is bogus, according to whether or not I have $1 less or $6 more.

 

I thought I clarified this in a later post. When I refer to double-dipping, I am referencing getting two deductions for the same transaction. I buy a piece of property. I get two deductions related to the purchase of that property. One is a cash outlay expense (the $1 spent). One is a non cash outlay expense. This allows me to make it seem like I lost $$ when I really didn't, in that specific period.

This isn't necessarily true, as far as my profit and loss is concerned. If I take excess depreciation in one period to create a loss and don't pay taxes on my gain, then I roll my gain into another asset that I don't sell, then I can get away with never paying tax on my gain. That's essentially making the loss permanent and never catching up in another period, as far as paying taxes is concerned.

A paper gain and a gain in reality are two different things. I agree that you can see all of that, or see anything, by looking at someone's books in detail.

 

I disagree with you entirely. The $10 payment is not an expense. It is partially an expense. You have the money in your pocket, but you may have made more or less than that depending on the amount of your payment went to principal. Everybody including the IRS cares about the income less interest and depreciation.

I pay $100,000 for a rental house with cash. I rent it out for $500/month. According to you, I have a $500 profit.

Now I buy that same house with 100% financing. I rent it out for $500/month, and make monthly payments of $500. According to you, I have no profit or loss.

Please stay far away from my profession.

Edit: I'm not trying to discount the value of a cash flow statement. Balance sheet, income statement and statement of cash flows are all needed to accurately determine the health of a company's finances.

 

But you don't get two deductions. When you depreciate property, you don't get to expense it initially. If you spend $50,000 on a car and depreciate it over 5 years, the only expense on your books is $10k per year. That first year, you actually pay the $50k but you don't get to expense any of that.

 

First, I don't see how you can depreciate something you don't own, I don't see it as applying.

Second, depreciate real estate seems like a bad example. For the most part, houses do not depreciate, so it is harder for me to visualize, though I get your point. I see auto's much more clearly.

I have $20k
I purchase the car for $20k cash (to keep it simple)
After 2 years I want to sell the car and can do so for $16k.
I've lost $4k because the asset depreciated.

Even if I am to lease the vehicle or use it make money somehow for $1k a year, then I've lost $2k. I may have more cash in hand during those 2 years, but overall, I've lost money.

If I can make $3k a year from the lease of the vehicle, then I start making a profit off the car.


The point is that depreciation is not just a paper loss. It may not effect the cash in your pocket, but it's suppossed to reflect the loss in value of the property you own when new items sell for less then used, money that you eventually will lose. Granted, there are taxes, the ability to invest, what the actual value is to you, etc, that change things. Regardless, it is ignorant to only consider the cash in hand and not the value of your assets when determine whether an investment is profitable.

 

I personally care about the $1 loss. It would have been smarter for me to keep my money under the mattress then to buy this property. Note, I'm assuming that the depreciation reflects reality, that after a year, i could sell my property for $7 less then the original purchase price (Not even factoring closing costs, agent fees, etc)

 

You own the team, which is what in reality you are depreciating. You are depreciating a portion of what you paid for the team.

The reason we are comparing it to real estate, is that both typically appreciate in value, so there is the argument that it is not a loss, since your net worth is not effected by the depreciation, like it would be with an automobile. I think it is a fair argument.

My opinion is that an asset like that is typically held on for such a length of time, is used to produce your income, and you may never actually sell it to realize the gain, so depreciation is a reasonable expense.

If we only looked at cash flows, it would be unfair to compare the a team heavily financed versus one that has little financing.