Oct. 2, 2016 9:34 a.m. ET
The portions of Donald Trump’s tax records that became public this weekend fill in pieces of the puzzle of his financial dealings but open renewed questions about how successful he is and how much tax he has paid while accumulating his fortune.
The state tax documents from 1995, published by the New York Times , show that the Republican presidential nominee reported a $916 million loss that year, letting him soak up years of future income without paying taxes. The documents raise questions about how exactly Mr. Trump generated losses during the nadir of his business career that were large enough to exceed the income he likely reported when his debts were forgiven.
Mr. Trump had a series of business failings in the late 1980s and early 1990s in the casino industry and other ventures, followed by more-recent success on television along with his hotel and golf-course operations.
The U.S. taxes income, not wealth, and savvy taxpayers often try to avoid reporting much of the former while generating the latter. They are usually not trying to do so, however, by actually losing money.
The tax treatment of losses, bound to become a subject of national debate, is a normal, usually uncontroversial feature of the income-tax system. The government doesn’t pay net refunds when business owners lose money, but it lets taxpayers use those losses to smooth their tax payments as they make money. That reflects the fact that “the natural business cycle of a taxpayer may exceed 12 months,” according to a congressional report.
Typically, for federal returns, such net operating losses can be carried backward for two years to offset past income and then kept on a taxpayer’s books for 20 years going forward, though Mr. Trump’s losses could only qualify for a 15-year carryforward under the law at the time.
Also, real-estate developers can generate losses more easily than other taxpayers. First, they can take deductions for depreciation of their property. Second, they deduct the interest when they borrow. And third, unlike investors in other businesses, they can use those losses to offset their other income.
During his first presidential debate with Hillary Clinton last week, when she cited previously available records showing he hadn’t paid taxes in some years, Mr. Trump said that was “smart.” He is the first major-party presidential nominee since 1976 to refuse to release his own tax returns.
“Mr. Trump is a highly skilled businessman who has a fiduciary responsibility to his business, his family and his employees to pay no more tax than legally required,” his campaign said in a statement released late Saturday.
The statement said Mr. Trump has paid hundreds of millions of dollars in various taxes, including “federal taxes” and “state taxes” but not specifically “federal income taxes” and “state income taxes.”
It can be smart to avoid paying taxes if you’re using tax breaks encouraged by the government or exploiting gaps in the system. It isn’t necessarily smart if a $0 tax bill results from actually losing money or not following the law.
“Really bad business decisions, like losing money in the casino business, generate real economic loss,” said David Herzig, a tax-law professor at Valparaiso University. “These losses are not ‘gold’ but the real loss of gold,” he said.
This weekend’s revelation helps explain a carefully worded line in the letter that Mr. Trump’s lawyers released in March, when they detailed his history of Internal Revenue Service audits.
The audits of Mr. Trump’s tax returns from 2002 through 2008 were “closed administratively by agreement with the IRS without assessment or payment, on a net basis, of any deficiency,” wrote Sheri Dillon and William Nelson of Morgan, Lewis & Bockius LLP.
That sounds at a glance like the IRS found no problems in his returns. But all it actually says is that Mr. Trump didn’t pay the IRS any taxes as a result of the audit. That wording, tax lawyers told the Journal in August, is consistent with an audit that affected his ability to use his net operating losses but that didn’t result in immediate payment.
For example, if Mr. Trump was still carrying forward $200 million of losses and the audit reached the conclusion that he had $100 million more in income than he claimed, he wouldn’t have to pay, but the audit would hasten the day when he would start paying. Mr. Trump’s lawyers have said he is being audited for the years since 2008 and he has cited that as a reason for not releasing his returns, although he isn’t prohibited from doing so.
The losses from the 1990s may also explain some of Mr. Trump’s recent transactions.
Since casino records previously showed that Mr. Trump had net loss carryforwards at the end of 1993, the 1995 losses may stem from multiple years. The losses from that era are expiring or have expired and are now less available to soak up his income, even if they haven’t been used up.
When that happens, a taxpayer looking to cut his tax bill would seek of lowering his taxable income—and that is what Mr. Trump did in 2014 and 2015. In each of those years, he donated what is known as a conservation easement, essentially extracting income-tax deductions out of properties he had owned for more than a decade.
In 2014 Mr. Trump pledged not to build houses on the driving range at a golf course in California. And in December 2015, typically the time for planning at the end of a tax year, he set aside 74% of his estate in Westchester County, N.Y.
The preserved property in New York contains “scattered but impressive” stands of huckleberry, the homes of brown bats, potential habitats for mountain dusky and spring salamanders, and “mature mixed hardwood forests” that “are valuable in terms of removing CO2 from the atmosphere,” according to the document Mr. Trump signed. He said earlier this year that he is “not a big believer in man-made climate change.”
The charitable deduction in those cases is equal to the difference between the value before he grants the easement and afterward. Taxpayers have 15 years to claim the deduction, so they wouldn’t want to start that clock ticking unless they had or expected taxable income.
Mr. Trump also, however, donated conservation easements in 1995 in Florida and in 2005 in New Jersey, and he could have claimed a $39.1 million deduction for the latter, according to local records.
Write to Richard Rubin at email@example.com