Couple questions about passive MF investing

9 Replies

Hello everyone,

I am going to invest in some syndications and i wanted to raise a couple questions here for advice.

1. my SFHs I have in LLCs. What are the advantages of putting the MF investment into a disregarded LLC vs in my private name?

2. Whatnare the disadvantages of putting a MF passive investment into a C Corp? This would allow me to deduct a lot of "general" expenses and shelter the income, however is this wise? I know with SFH it is problematic.

3.  Do people typically do 1031 exchanges with syndications or end up paying tax on the capital gains when exiting the deal?

4. Tom Wheelright advises not to own real estate in a SD IRA. What about owning shares in a passive real estate deal. Has anyone ran into tax issues on the SD IRA by participating in passive multi family deals?

Thank you in advance!

@Cherry Patterson you have some great questions.

1. I cannot think of any advantages of putting your investment in an LLC. Most syndicated offerings are already structured as LLCs and as a member of the LLC your liability is already limited to the amount of your investment. One could argue that there are some tax savings because perhaps you could deduct some "general expenses" but I think the cost of establishing and maintaining an LLC might wash that benefit. Or perhaps not, but you'd have to study how much you have in general expenses and if it really would be deductible to decide whether there is any benefit. Most of our investors that invest in our offerings via LLCs do so because there are multiple members, such as in a family office or where a group of friends or family pool their resources to invest. They aren't doing it for tax or liability reasons.

2. I think this is a tax question best answered by tax experts.  I know that in my 30 years in this business I've heard over and over not to place appreciating real estate in C corps.  So I just don't do it--but I can't give advice on it.

3. Typically not.  Most syndicated offerings are not eligible for 1031 exchanges unless the entire group is exchanging out of one property and into another.  This is very rare--more often than not someone wants to enter or exit the investment, or the sponsor wants to get paid their promote so the 1031 can't happen.  There are some groups out there doing (or claim they can do) drop and swaps but to most sponsors that's just a tangled web of complexity so you don't see this very often.

4. We have tons of investors in our offerings using SDIRA money. There can be some tax issues with being subject to UBTI but comparing the after-tax performance of a syndicated offering versus other IRA-appropriate investments can make the syndication investment just as attractive if not more attractive than the alternatives. And after many years in this business and a lot of SDIRA investors, I've never heard any of them say that they wish that they hadn't invested their IRA money. But we have had plenty that have declined to invest in the first place due to UBTI--but they are just missing out!

Hope that helps.  Good luck!

@Cherry Patterson

1) as Bryan said, there are no advantages from the point of you of liability protection. However there are some people that I know that will do it because it allows them to deduct investment expenses that can't do on the personal taxes, because there is a 2% floor. For example, if you make $100k a year and have $1500 of investment expenses with subscriptions, newsletters, etc., you can't deduct that on a personal investment because it is under $2000. But you could set up an LLC for a couple hundred dollars a year, and then the difference is your savings. On all of this, check with your accountant as I am not one.

2) C CORP: It will almost always not be worth it to you because a C corporation is double taxed. You are taxed at the corporation level, and then again when you distribute the money to yourself. S corporations are also usually not used for real estate, because to do them properly you will end up having to pay social Security and payroll taxes, that offset any savings. Typically people use an LLC. But check with your attorney to find out the best thing for you.

3) 1031 exchange:  most syndication/Crowdfunding don’t offer this, however there are handful that do. There are some investors that have invested with such sponsors over many decades, and never had to pay taxes. 

4)   To maximize the tax savings and reduce penalties, most investors will put their SDIRA money  into no leverage debt funds (which avoids penalty taxes  and can best utilize the tax savings ).  Then for leveraged equity funds, they use cash. (Since there are some tax advantages with depreciation, that you can fully take advantage of when you use cash).

@Cherry Patterson You have received a great feedback from @Brian Burke

I  want to give some food for thought on #4. If you own a business and don't have any employees, then you may potentially be qualified to open solo 401K. This type of pension plan not only allows you to shelter up to $55k a year growing tax free, but it is also excluded from UDFI and UBTI rulings so it will not trigger and unrelated business income tax (UBIT).

My very best!

Originally posted by @Brian Burke :

@Cherry Patterson you have some great questions.

1. I cannot think of any advantages of putting your investment in an LLC. Most syndicated offerings are already structured as LLCs and as a member of the LLC your liability is already limited to the amount of your investment. One could argue that there are some tax savings because perhaps you could deduct some "general expenses" but I think the cost of establishing and maintaining an LLC might wash that benefit. Or perhaps not, but you'd have to study how much you have in general expenses and if it really would be deductible to decide whether there is any benefit. Most of our investors that invest in our offerings via LLCs do so because there are multiple members, such as in a family office or where a group of friends or family pool their resources to invest. They aren't doing it for tax or liability reasons.

2. I think this is a tax question best answered by tax experts.  I know that in my 30 years in this business I've heard over and over not to place appreciating real estate in C corps.  So I just don't do it--but I can't give advice on it.

3. Typically not.  Most syndicated offerings are not eligible for 1031 exchanges unless the entire group is exchanging out of one property and into another.  This is very rare--more often than not someone wants to enter or exit the investment, or the sponsor wants to get paid their promote so the 1031 can't happen.  There are some groups out there doing (or claim they can do) drop and swaps but to most sponsors that's just a tangled web of complexity so you don't see this very often.

4. We have tons of investors in our offerings using SDIRA money. There can be some tax issues with being subject to UBTI but comparing the after-tax performance of a syndicated offering versus other IRA-appropriate investments can make the syndication investment just as attractive if not more attractive than the alternatives. And after many years in this business and a lot of SDIRA investors, I've never heard any of them say that they wish that they hadn't invested their IRA money. But we have had plenty that have declined to invest in the first place due to UBTI--but they are just missing out!

Hope that helps.  Good luck!

Little to add here, but  couple of additional thoughts:

1. I am not sure whether Brian still accepts sophisticated but unaccredited money, though many of us do. However, in a Reg D, SEC only allows 35 unaccredited partners. Any LLC which has at least 1 unaccredited member also counts as an additional unaccredited member. So, if you happen to be doing well financially, but are unaccredited, you'd be shooting yourself in the foot relative to your chances of getting into a deal with a syndicator who accepts sophisticated money, because they wouldn't want to loose 2 out of the 35 spots for one person.

2. S Corp converts part of the earnings from earned income into passive. Since passive income from RE is passive to begin with, you'd be accomplishing exactly nothing :)

Hope this helps.

@Cherry Patterson you already got some great answers above. Here is my .02

The answer to both questions 1 & 2 should be answered with someone's full financial landscape in mind. The best person to answer that is your CPA/tax advisor. Since I don't have all that information it's really not a good idea for you to take any answer I might give you because it might be right for me but wrong for you..

1031 is usually not an option in syndication because it's designed for "like kind" exchange and while many people stretch the definition of "like" IRS will not take exchanging real estate with securities (in syndications you buy shares of the LLC).

Only way to do that is if the sponsors somehow structure the holding in a way that the investors are TICs but I personally haven't seen one done this way. 

Tom's advice comes from a place of tax thinking. If you can't get the tax benefits (depreciation) then you shouldn't do it. I don' like letting the tail wag the dog.

If your SDIRA can make more money (% returns wise) in a safer vehicle (RE over market) then I say go for it. If you have a better & safer way to get returns on your SDIRA money then do that but I don't take blanket statements from anyone!

@Cherry Patterson Great info from @Brian Burke  @Ben Leybovich @Ian Ippolito

One thing to add on #3 which nobody has touched on. I have seen syndications that will accept 1031 money, but usually this done through a TIC (Tenants in common) entity instead of LLC or S-Corp. The one major disadvantage of using a TIC, is it may be harder to finance, because banks would rather lend on a whole property, and not just pieces.

1. my SFHs I have in LLCs. What are the advantages of putting the MF investment into a disregarded LLC vs in my private name? 

There is an added layer of protection and it keeps it as a separate business in case of a personal lawsuit or a lender coming after your personal assets. You can also get tax write offs if you travel to the property or spend money on the LLC for business. Depending on what state you are in maintaining an LLC is expensive. In MN it is free after the $160 set up, but other states charge much more. 

2. Whatnare the disadvantages of putting a MF passive investment into a C Corp? This would allow me to deduct a lot of "general" expenses and shelter the income, however is this wise? I know with SFH it is problematic. 

I don't see any advantage to this

3. Do people typically do 1031 exchanges with syndications or end up paying tax on the capital gains when exiting the deal?

Not typically, but there are vehicles for this and companies that specialize in it. Most companies today are doing a DST, but some still offer a TIC. This is typically done from the onset.

4. Tom Wheelright advises not to own real estate in a SD IRA. What about owning shares in a passive real estate deal. Has anyone ran into tax issues on the SD IRA by participating in passive multi family deals?

I have plenty of passive investors using SDIRA/401k money. Their are some downsides, but when you look at the returns and security, I think that it is worth it. Everything equal, if you have a pile of cash to invest, do that first, but looking at investing in a mutual fund vs real estate in your IRA, I would take the Real estate

Thank you in advance!

Originally posted by @Cherry Patterson :
2.  Whatnare the disadvantages of putting a MF passive investment into a C Corp?  This would allow me to deduct a lot of “general” expenses and shelter the income, however is this wise? I know with SFH it is problematic.

Many people seem to think that simply opening a company will allow for additional expenses.  This is not the case.  If it is an ordinary and necessary expense it will be deductible anywhere.  A entity isn't a license to cheat on your taxes.

Disadvantages - Double taxation. If you wanted to remove it for personal use or otherwise you would have to sell it to yourself at FMV which would likely be a taxable transaction. No ability to offset losses against other income sources.

@Cherry Patterson

On question 3 - there are some very specific rules to follow for a syndication to be 1031 eligible. The main thing to know is that there can't be any features that resemble a partnership or different classes of investors in order for the IRS to bless it as 1031 eligible, so no promotes or waterfalls allowed. The syndicator would make their money through acquisition, asset management, property management and sometimes disposition fees. The old TIC structure is really very bad but some people still do it. The DST (Delaware Statutory Trust) structure is where most of the 1031 money goes now, where investors buy beneficial interests in the trust, a master lease is put in place with the sponsor acting as master tenant and distributing funds in the form of "rents" to the investors. I work for the largest 1031 syndicator in the country, and I would be happy to give you some more detailed information on how that works if you are interested, feel free to message me.