Realizing tax benefits while investing in a syndication deal

20 Replies

Curious to understand some of the tax-related nuances with regard to taking a more passive approach through a syndication investment. Specifically, how this type of investment is typically treated for tax purposes (i.e. can you still realize benefits such as depreciation, cost segregation, etc.) and what gotcha's exist to look out for (creating an entity to invest etc.)?

This all depends on the sponsor and the deal. Some will allocate depreciation on a pari passu basis, some will pass along all benefits to the investors and some not at all. 

@Jason Padgett As @Greg Dickerson said there are several ways that syndicators will structure the operating agreement, and that will dictate how much if any of the depreciation is passed through to the investors.

The most common scenario I've seen, is where the investors receive an equity stake in the property, as an LP, according to the percentage of their investment in the deal. In this case they would receive depreciation (and accelerated depreciation or 100% bonus depreciation with cost segregation) according to their percentage of ownership.

Let's say they invested $100,000 which acquired 5% of the equity. The depreciation could be $500,000 in the first year (or first 5 years), they would receive $25,000 (5% of $500K) of depreciation write off. If they received a 10% return, (which is great!) they would have $10K income, and $25K write-off = -$15K (negative passive loss). Now how much of that passive loss, if any, can be used to offset other income will depend on A) if they are a 'real estate professional' B) if their not a REP if they have an AGI, adjusted gross income of less than $150,000 (which is pretty unlikely in our scenario if they invested $100K)

That passive loss will be carried forward into future tax years, if it is not utilized in the current year.

Originally posted by @Peter Schuyler :

@Michael Bishop

Have you ever taken the cash out proceeds of a syndication and 1031 into another syndication avoiding that large capital gains tax at the end of a syndication where the sponsor sells the property(s)?

 You can't sell or take out the proceeds from an investment in a partnership/syndication to 1031 into another partnership investment/syndication.
The rare exception would be if the syndication was set up as a tenant in common(very rare).

@Jason Padgett

When you invest in a partnership or syndication, the tax benefits you receive are based on the decisions that the partnership/sponsor will make.

If you invest in a syndication that invests in real estate, you are entitled to a share of the syndication's profit and losses.
The number you receive from the syndication factors in depreciation, cost segregation(if done), etc.

Now, the there are a couple things to concern yourself when investing in a syndication from a tax perspective.

You may or may not be entitled to report the losses if losses are reported to you. This will depend on several factors such as your ownership percentage in the partnership and how active/passive you are.

Another thing to consider is if it opens you up to filing in multiple states. You may be required to file in state returns wherever the syndication does business in.

Originally posted by @Basit Siddiqi :
Originally posted by @Peter Schuyler:

@Michael Bishop

Have you ever taken the cash out proceeds of a syndication and 1031 into another syndication avoiding that large capital gains tax at the end of a syndication where the sponsor sells the property(s)?

 You can't sell or take out the proceeds from an investment in a partnership/syndication to 1031 into another partnership investment/syndication.
The rare exception would be if the syndication was set up as a tenant in common(very rare).

Ok, so the interest month to month inside an SDIRA is not taxed until taken out years from now, the tax benefits vary syndication to syndication, but the large proceeds at the end, if they sell or along the way or if they refinance, would be taxed at capital gains or would that just be feed back into the SDIRA as a large sum?

 

Hello, if you are looking at a couple of Syndications and ask them those questions. We do cost segregation study and the depreciation flows to everyones K1. I would check out a couple of youtube videos on the subject.

Originally posted by @Peter Schuyler :

Ok, so the interest month to month inside an SDIRA is not taxed until taken out years from now, the tax benefits vary syndication to syndication, but the large proceeds at the end, if they sell or along the way or if they refinance, would be taxed at capital gains or would that just be feed back into the SDIRA as a large sum?

it remains in the SDIRA

 

 

Syndicators should not be answering lots of tax questions or giving legal advice. The passive investors should rely on their tax professionals for guidance.

@Jason Padgett -- a few comments.  

1. Of the 100's of MF syndications I have seen, I recall only one or two that did not share the depreciation pro rata.  In those two, the SDIRA folks got a different status.  If you are using non-qualified money, don't do a deal that doesn't share.

2. A 1031 is highly unlikely in a syndication deal. I have heard of it happening one time. The members of the selling LLC stayed together and bought another property. Don't count on it. I am lead to believe that an individual's portion of a syndication may not be 1031'd out of the deal, not into for that matter.

3. Recently, I've seen two syndication deals that were also TIC deals to allow a person to roll into the deal, albeit, not the syndication portion. And I have heard of TIC (only) deals that received 1031 funds.

4.I am in TX with no state income tax. So far 3 out-of-state deals have sold.  The two in NM did composite returns.  The Lead in the CO deal got excited to distribute and forgot to do one.  I was told that some states allow composite returns, some don't.  Unconfirmed, so rumor at this time.

5. The excess bonus depreciation (for non RE Pros) is available to offset other passive income.  Say you happened to sell all that Apple stock that year.  Follow me!  It is not a huge help on your first RE investment, but say you sell that one - double your money, so you have $75K cap gain.  You take the $100K investment and buy another property.  The bonus depreciation on this one can be used to offset the profits on the first one.  So you get to push the tax liability into the future.  Bonus Dep will likely disappear when the wind in Washington changes, enjoy while you can.

6. WRT SDIRAs, be aware of UBIT & UDFI.  After my search for experts, I observe this is not a well understood part of the tax code.  Finally heard a good description from Quest Trust's Rebecca Miller on a Brad Sumrok youtube video - link below, go to 20:45.  Actually, it is all pretty good.
https://www.youtube.com/watch?v=3TEpZ_0x3io

Regards,

Charles LeMaire

@Charles LeMaire

Actually, what the young lady from Quest outlined with respect to UBIT taxation is inaccurate.  

She indicates that when investing in a syndicate that is formed as a LLC, that creates the potential for pass-through taxation of the K-1 income to the limited partner. She makes it seem as if any investment in an "business entity" will create Unrelated Business Taxable Income (UBTI). This is simply not true. If the underlying income producing activity is passive in nature, such as rent from real property, then there is no tax implication in the form of UBTI. A syndicated investment for the purpose of conducing a trade or business would create UBTI on that trade or business income. Things like development of property for immediate sale might fall into this category. Most real estate multifamily investments are not operating businesses, but create passive income from rents.

Most syndicates do use debt-financing, which does create exposure to UDFI.  The tax impact is generally negligible - on the order of a few hundred dollars per year on a $100K limited partner investment.

The marketing folks at IRA custodians are not tax advisors.

@Greg Dickerson on here using Latin.  I never heard of "pari passu" before.  I had to look it up.  It means "side by side" for those like me that didn't know.  Thanks Greg for sharing.

@Peter Schuyler , the only way to 1031 your portion of a syndication sale is if the syndication has been set up as tenants in common structure or a Delaware Statutory Trust.  Proceeds from the sale of property by a LP cannot be 1031d by the members of the LP.

If you 1031 into a TIC or DST you can some lose control and timing of the exit. TIC you tend to have voting rights individually so if lots of investors can be a mess deciding on any problems that come up while owning the asset.

There are also UPREIT's

If you are worth 50 million exchanging 1.5 million into something and want go one of the 3 routes you lose control and exit timing then maybe not such a big deal.

If you are worth 2 million and this 1031 - 1.5 million has made it to where you can retire off of the cash flow then giving up control and timing can be HUGE versus owning yourself directly.

A lot of good points.  I am not affiliated with any Syndicators but have invested with one in particular since 2016.  I have been involved in several deals since that time and two of them have sold.  The first one did not have the option to 1031.  Just prior to the close of the second deal, those investors that chose to 1031 could roll their winnings into another deal that was offered by that syndicator.  

I am a full time RE Professional so my passive losses do offset other income, including that of my spouse.  Being a REP is a game changer for high tax bracketed individuals.  The huge negative K1’s received from syndications are also a massive benefit.  Of course there is depreciation recapture and capital gains upon sale if you don’t 1031.  One option is to stagger your syndication investments so your cap gains are offset by the cost seg/bonus depreciation etc. of newer investments.  Good luck!