QOTW: What are your best (and legal) tax saving strategies?

[Alicia Marks]

Since it's almost the end of the year, I wanted to focus our question on ideas and strategies that can help us make last minute changes to help lessen the tax burden, or to start the year with best practices.

Let's help our community with our best legally allowed options to save on taxes. Please make sure to note if it is specific to a state, asset class, or other specifics.

Want a quick list from one of our resident experts? @Ali Boone wrote a fantastic blog you can find here: https://www.biggerpockets.com/...

[Jack Martin]

I would echo cost segregation / bonus depreciation, particularly when applied to mobile home parks.  As mentioned by @Paul Moore above, investors can achieve passive losses in year one of 100% of their investment. For investors who have experienced significant passive gains, having access to those kind of passive losses can make a huge impact on their tax strategy. This strategy may not be appropriate for short-term deals or other types of real estate, but with MHPs it is incredibly powerful.  

Example: an investor experiences a $1MM gain from the sale of an investment property and cannot find a suitable replacement property for a 1031 exchange, therefore is staring at a $400k tax bill. 

Solution: invest the $1MM gain into a mobile home park syndication where cost segregation / bonus depreciation is being utilized. 

Result: investor receives passive losses on K1 of $1MM, therefore eliminating the $400k tax bill that would have been due for that year. Over the life of the investment this means the $400k is now earning a yield as invested dollars (time value of money) so the investor is earning yield on the entire $1MM.  

Keep in mind, this is a tax deferral strategy, so at the end of the investment depreciation will be recaptured. However, the recapture occurs at a lower flat rate instead of the rate of a high income tax bracket, which gives the additional benefit of tax arbitrage. 

Again, this strategy may not be appropriate for smaller properties or short-term deals. It can be applied to other real estate types as well, but the benefits within MHPs far outweigh other commercial real estate.  This is due to the large portion of a mobile home park's value being allocated to land improvements, which qualify for bonus depreciation. 

All the best, 

Jack

[Bud Gaffney]

@Alicia Marks this forum is awesome! Thanks for the insights everyone.

[Vic Reddy]

@Venu Vedre - Nope. The way I understand u don't own real estate, only member in LLC. The LLC can do 1031 but not individual members

[Elizabeth M Williams]

@Todd Goedeke there are a lot of syndicators who've gone multiple cycles with investors, as I'm sure @Paul Moore would attest. In picking the right syndicator, those fees are well worth the trade off of time & unexpected expenses, and often outperform individual real estate deals. We have had investors do exceptionally well in Phoenix, for example, doubling their investment in 18 months to 2 years, and those investors are taking advantage of 1031 exchange to move from one exit into the next deal. That's a pretty impressive return, and an outlier, but investors have normally had returns of 15-30% annualized, consistently, through multiple cycles. 

[Alicia Marks]

Originally posted by @Bud Gaffney:

@Alicia Marks this forum is awesome! Thanks for the insights everyone.

 Thanks Bud! I am always looking for discussion topics or common questions throughout the BiggerPockets community. Anyone can message me with questions or suggestions on how to make this community great!

[Todd Goedeke]

@Elizabeth M Williams You work with and get paid by syndicators when you place investors’ money with syndicators. That fact qualifies your opinion as biased toward syndications.

 You speak in generalities while mentioning a single deal. Accredited investors don t need to rely on a syndicator and it’s property up charge to find a good deal. Many individual investors network to find great deals without needing to enlist/pay for a commission advisor to steer them into securities related RE syndications.

[Elizabeth M Williams]

@Todd Goedeke it was actually the other way around for me. I spent months digging into buying other investment properties, vs investing in a syndication, and spoke with cpas, lawyers, other investors (of single families, apartments, multi families, and syndications), capital raisers, and syndicators (small and large), and got a lot of perspectives and advice from all of them. Met some lovely people along the way. Once I understood the ins and outs of it, and having been a landlord for 25 years now, I invested. So my 'bias' started with my own money. Not only did I invest, but I wanted to work in the space, as I, as well as a LOT of investors out there, find it a very attractive alternative to the time and energy and expense involved with sourcing, renovating, managing these deals. 

I invested a lot of time and money to become SEC registered, specializing in private placement of capital. The exam process was tough. I wouldn't have gone through this, in my early 50's, if I wasn't so passionate about it. I'm not alone in this. Institutional investors are paying a premium to buy up these portfolios, as it's a stable way for them to buy cash flows. Plenty of buyers for the smaller deals, too. Who doesn't like a well-managed cash flowing property?

Re mentioning one deal, I said it was an outlier, and the other range was accurate. I cannot mention specific deals for a few reasons - one, I'm an SEC rep, as I said. That means I have to follow stringent guidelines with respect to advertising/marketing. Two, Bigger Pockets has very stringent guidelines, and I've had comments taken down in the past when I was more specific. Happy to chat off the forum, if you'd like. 

You mention commissions. Any private equity raise has an acquisition fee, whether you work directly or indirectly with a sponsor of the deal. This is industry standard, so many brokers/advisors simply work as part of investor relations, so fees aren't increased by working via a broker. And returns to investors are net of all fees, so if someone invests $100k into a private equity deal, they get $100k worth of capital in the deal, plus distributions and returns derived from a capital event. 

Yes, accredited investors could go out and find their own deals. But that is active investing. I have friends who do syndications, and I admire them for it. It's a LOT more work, and often they get hit some obstacles on their first few deals, without the benefit of experience, which has an impact on either their returns or their exit strategy, or both. Some get lucky and knock it out of the park on their first deal or two. Thankfully there is a good network of people out there helping each other out as they progress along the learning curve. 

It's really a matter of what you want to do, isn't it? Some people LOVE buying a bunch of rentals. Some love flipping. Some form syndications with friends and family money, and go on to be very successful. But a growing number of investors are happy to find the right sponsors, who have a lot of experience on their team, who have exited many deals, who have already cut their teeth on painful lessons. Having spoken with friends who are syndicators (ie active), their returns on their first few deals aren't usually superior to returns that investors get with established syndicators. Personally, I would happily have a team who knows their market, has contractors and property managers and banking relationships well-established, do the work for me, because I'm able to earn returns passively (with a lot less volatility than the stock market). I mentioned one deal, but there have been several with that operator with similar returns, and the range in other markets has been what I mentioned in my previous comment, with multiple operators, over multiple exits. I'm just mindful of my wording in this forum. Plenty of other capital raisers here on BP who've delivered similar results for their investor base too.  

I will also add that investors are nearly always repeat investors. Once investors find good partners/syndicators, they tend to stick around for years, especially when deals have been exiting within a few years, and they can roll proceeds over into the next deal. And I'm not speaking just about myself. I know a good few people in this business, and their investor base is loyal.

I have a lot of respect for and am constantly impressed by the clever real estate investors/entrepreneurs out there. There are many ways to skin a cat. For accredited investors (though not all deals are limited to accredited investors), it's nice to plant those investment 'seeds' across multiple markets, in multiple sectors, getting the upside of appreciation/depreciation/tax advantages/distributions that real estate offers, and passively doing it via syndications is a model that works for many. I just sold a house, worked with my cpa on tax planning, and invested straight into 5 deals. 3 were with syndicators I raise for, 2 were not, as there are a lot of interesting opportunities out there in commercial real estate, and I'm always open to new opportunities for myself and clients, some of which are outside of the niche I work in. If I had more money I would have liked to invest in a farmland deal I found, as I really am a fan of diversifying across location and asset type. 

As a footnote, my husband is Australian, and we have, after a lot of digging around, found a few syndicators/funds in Australia, that we plan to invest in, via his retirement account, as well, which are not multifamily. So yes, it would be fair to say that I'm a big fan of this approach :)

Horses for courses, as they say. If what you're doing works and you enjoy it, stick with it. But please respect this approach, too. A lot of work goes into vetting deals/syndicators, to mitigate risk as much as possible for investors, which is why good private equity raisers have a base that sticks with them for many years.

Happy holidays & I wish you continued success :)

[Todd Goedeke]

@Elizabeth M Williams your answer avoids my question about fees and commissions( referral fees) involved in a syndication. The typical syndication has upfront fees and organizational costs of 12%+. That means for every $1 million in investor money only 88% or less is invested in property. Only 88% of original capital is earning cash flow. The property needs to appreciate 14% before an investor receives any profit because of the upfront costs.

If syndications are so successful why aren’t investors using BP as a soapbox to voice their returns!

I ve seen syndications and their organizational fees over the last 30 years. They have produced lots of losses for investors when projections failed to materialize.
The only guaranteed winner in a GP organized syndication is the GP and referral advisors who get paid upfront regardless of whether there is property cash flow or appreciation.If that’s not true please state one syndication where the GP or advisor like yourself does not get paid till after there is a sale or refinance.

[Elizabeth M Williams]

@Todd Goedeke not sure where 12% upfront figure comes from. Equity placement fees are much lower in RE than in most private equity deals, and I've never seen a deal with more than 3.5% for that, which is on the high side. I don't know of any referral fees, it's a job, which involves a great deal of time & expense, and brings a lot of value to investors, as it is the job of the capital raiser to research opportunities, vet, educate, manage investor relations on an ongoing basis, and ensure suitability for investors.

Also, appreciation is only one way of delivering returns. Value add renovations, streamlining operational costs, acquiring off market/below market, rent increases (inline with current market & post reno, creating appreciation via increased NOI), incremental revenue streams, operating in growth markets (driven by data) - these are all ways to deliver returns.

The asset management fees tend to be along the lines of 1-2%, and sponsors make the lion's share of their returns on exit, after distributing returns to investors. There are hurdles to be made before they make any significant returns, an waterfall structures, as well. 

I've also seen a number of bad deals come across my way. But I wouldn't touch them with a ten foot pole. 

Re your comment about why aren't people on a BP soapbox? I can only speculate that it's for the following reasons - these deals often oversubscribe, investors who want in very often can't get in, as so many investors from previous deals roll into new ones. Not everyone is generous in sharing. BP is pretty strict on promotion/naming deals/syndicators. Having said that, it was on BP that I first was told about syndications. Many of the investors aren't on BP, many haven't even heard of it. Those invested, working with one capital raiser (who can often access a variety of syndicators), aren't active on BP, or perhaps are merely to seek out other info, eg tax related. 

I really can't speak to that, but can point you to data once, showing that MF investment is smashing records - 

Q3 2021 US Multifamily Figures | CBRE

Lastly, as I said, happy to take this discussion offline, and share info with you that way. In composing this, just glanced at one of our operators, have exited over 30 deals, over 30% IRR to investors. As I said, investors tend to get 15% annualized on the low end, ranging up to 80% on the high end. Me, I invest anticipating the low end, the rest is a bonus. For those who don't want to participate in the equity split, plenty of deals with 9-10% class a shares, with same tax benefits. I'm invested in a few of these, myself. Heck of a lot less volatility than the dividend producing shares/CEFs in the stock market, a lot less capital reduction exposure, IMHO.

[Paul Moore]

@Jack Martin, That was one of the best and clearest explanation I’ve heard on this topic, thanks!

@Elizabeth M Williams, likewise I appreciate your explanations of how and why you’re in this business.  I also got into syndications in my early 50s and I’m so glad that I did! Though I had been in real estate since my 30s.  

@Todd Goedeke, feel free to PM me and I will be glad to show you some real full cycle returns that are quite convincing. I will say that I understand your 12% comment in the sense that a 3% of asset price acquisition fee could be 12% of the equity with 75% leverage. My firm would not want to invest in a deal like that.