Tax implications of investing in a syndicated deal

12 Replies

I just read this great article by @David Thompson, and want to check my understanding of taxes for limited partners in real estate syndication.

- Income distributions are taxed at ordinary income rates, but there may be no taxes at all if there are "paper losses" from accelerated depreciation.

- If cash is returned to the investor through a refinance, that is a partial return of equity and a non-taxable event.

- When the property is sold, any gains are taxed as capital gains. 

- A 1031 exchange of sorts is possible if you roll the sale of the limited partnership into a similar and larger limited partnership, but you cannot 1031 directly into your own property acquisition.

Am I getting this about right?

What have your experiences been (or those of your investors)?

Thanks!

If it is done correctly, the taxation for a syndication should look very similar to the way that profits are taxed on a single family rental owned by one person.   The key difference is the numbers get divided up by your ownership percentage.

So, yes, many of the things you mentioned are likely or possible.

You missed a couple of key points though. Syndications are usually done to take down larger commercial / multi-family properties Those properties are valued based on NOI. Unlike single family, a good operator can quickly drive up value and is not dependent on comps. A huge advantage of those deals is that once you drive up valuation you can do a cash out refi, which is not a taxable event.

On two apartments I invested in, I got 100% of my original investment back with a cash-out-refi after about 2 years, plus cash flow.  I've not yet paid any taxes on those.

@Rachel Bjorklund you're a quick study! @Greg Scott had a great response as well.

I would just add to make sure you have the appropriate CPA or CPA firm. As your holdings get more complex you'll need a strong team. Run all your questions by your team to get confirmation on your personal situation and perhaps get even more tax efficient.  Again, this is where an accounting firm with a specialized real estate team may needed sooner than later.

Happy Hunting!

@Greg Scott , it's always great to hear from another investor! Sounds like you've made some great investments. Do you plan to pay your portion of the capital gains tax when the property is sold or will you make an exchange?

@Ivan Barratt , thanks. You make a fantastic point about needing the right tax counsel sooner rather than later. I like to learn as much as I can on my own so that a) I'm better equipped to assess competence, and b) I can make the most of the time I'm billed for! But at some point, professional advice tailored to my situation will be necessary. Thanks for pointing that out.

@Rachel Bjorklund

When investing in a syndication your ability to do a 1031 exchange is limited.   

The owning entity, whether that is a person or an LLC, has to be the same on both the title for the previous property and the new target property. In other words, YOU cannot do a 1031 exchange in a syndication. You are an investor in an LLC syndication and the LLC owns the property. The LLC would have to do the 1031 exchange.

While feasible, it can be difficult to get everyone in the syndication aligned on that strategy.

A CPA or Tax Attorney can help you with your taxes, but they usually aren't that good at proactive tax planning. There are a number of strategies you can use on the front end or the back end to mitigate the tax implications.

@Rachel Bjorklund in order to do a 1031 RE exchange from say a SFR into a MFR, it needs to be done as a TIC or DST.

Most large syndicators will not want to do a TIC as it introduces risk for the other LP investors.

There are only a few syndicators who go down the DST path, as it too has its complication.

So in general 1031 exchanges are not favored by most syndicators. I am looking into an option I heard about but need to research more before I can speak about semi-intelligently.

@Rachel Bjorklund The blog run by @David Thompson offers a lot of value and is truly one of a kind. You are correct in your reading and echoing the posts above me, it becomes hard to do a 1031 exchange when dealing with syndicates. In an ideal situation, assuming the usual syndication model, one would, theoretically, have to have the same LPs invest in the newer deal with the same sponsor i.e. practically impossible. 

Rachel,

Here's the followup article that I think will provide more insight.  The partners I work with have had successful syndication deals where they 1031 from one property to the next.  Where we have restrictions is taking in 1031 money from investors or enabling investors in our LPs to 1031 to their own investments.  TICs and DSTs can handle the latter but at a high cost and complexity that may not be attractive but does offer something to consider.

https://www.biggerpockets.com/blogs/9145/65331-syn...

I'm with David Thompson, 1031 Exchange has some challenges, but it can be done fairly easily if you are prepared prior to selling the asset. 

Thank you for the additional insights!

@David Thompson , once again you already have an article that answers my question. I will follow @Omar Khan 's advice and check out your blog.

The takeaway for me is that if I want to defer paying capital gains taxes on a syndicated deal, I need to invest in sponsors who will utilize this option and that have strong acquisition capabilities (no use rolling over into a dud). And in any case, I should be always prepared to pay capital gains at exit because it's up to the sponsor to initiate the exchange (which may or may not happen).

@Rachel Bjorklund , I don't think that scenario of a syndicator having perfect timing to roll into the next project can be consistently relied upon as a business model.  If I was you I'd plan on tax and exit at every sale.  Build that tax into your return projections so you continue to evaluate opportunities apples to apples.  

And then use other opportunities to "rathole" those post tax returns into what will become life long tax deferred assets - either whole ownership of real estate or passive fractional where you actually own the underlying asset.

One trick ponies don't grab a crowd for long and you'll want a whole arsenal at your disposal to make the most of a REI career.

Some sponsors I know have held assets for 20 to 30 years. They take their back end sponsor equity and use that to buy out investors when they want to exit the investment.

I do not look at 1031 money for my projects. I do not want to use the TIC or DST model. TIC everyone typically gets a voting share. You have too many cooks in the kitchen when it comes to important decisions.

I do work with 1031 investors when they want to buy a commercial property to own themselves. I do the commercial broker thing and make a commission.

The TIC and DST are just not my models.

I do know some syndicators that would look at it for one deal but would have to be BIG money. Like 5,10 million exchange proceeds from one investor etc. not this 50k,100k,200k type stuff from an investor on a 1031. You would have to tee up too many small investors for DST,TIC.

As with anything in life it's an analysis of the hassle factor with the risk versus reward.   

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