First, let me take the opportunity to thank the BP community for the incredible (free) education I am receiving.
I have a question on the payouts from crowdfunding opportunities. How is that income taxed? It may very we'll depend on the specific deal. My real question is if these investments would be better sourced from an IRA or if there exist some tax advantages?
@Todd Michael if you are investing in the deal then I think a Roth IRA would be best because the proceeds would be tax free
Hi @Todd Michael . You've asked a seemingly simple question that unfortunately has convoluted answers, not because crowdfunding is convoluted, but, taxes across the states are complex.
I've asked my friends at Kingdom Trust for an answer on the IRA side and this is what they told me: "The answer to this question overall is that the tax consequences will vary depending upon the structure of each specific deal and how the return on investment is characterized. Those consequences will also vary depending upon whether the investor's residential status. However, by putting the investment inside an IRA, the investor enjoys the tax-deferred (Traditional IRA) or tax-free (Roth IRA) status conferred by those vehicles where the returns grow tax-free and are taxed, if at all, as ordinary income to the tax payer upon distribution."
Further to this, and if you don't mind the legalese, our general counsel has also chimed in with some info. Keep in mind that the following is related to deals that are interest bearing (debt) and not equity investments.
We strongly urge all prospective purchasers of the Notes to consult their tax advisors and/or attorneys regarding the U.S. federal, state, local and non-U.S. tax consequences of the purchase and ownership of the Notes, including any possible differing treatments of the Notes based on that purchaser's particular circumstance.
The payouts of interest may vary based on deal and the platform that you use. Your best bet would be to look through the Private Placement Memorandum (PPM) and give a copy to your lawyer or tax advisor to analyze. (Patch of Land continually revises its PPM and the topic is addressed on page 23 of our current investor loan package). At Patch of Land, we outline in our PPM that "although the matter is not free from doubt, Patch of Land (the "Company") intends to treat the Notes as indebtedness of the Company for U.S. federal income tax purposes. As a result of such treatment, the Notes will have original issue discount, or “OID”, for U.S. federal income tax purposes because payments on the Notes are dependent on payments on the corresponding borrower loan. Furthermore, a holder of a Note will be required to include the OID in income as ordinary interest income for U.S. federal income tax purposes as it accrues (which may be in advance of interest being paid on the Note), regardless of such holder’s regular method of accounting."
THIS DISCUSSION OF CERTAIN U.S. FEDERAL INCOME TAX CONSIDERATIONS OF THE PURCHASE, OWNERSHIP AND DISPOSITION OF PATCH OF LAND NOTES IS NOT INTENDED TO BE, NOR SHOULD IT BE CONSTRUED TO BE, LEGAL OR TAX ADVICE TO ANY PARTICULAR PERSON.
TO ENSURE COMPLIANCE WITH U.S. INTERNAL REVENUE SERVICE CIRCULAR 230, PROSPECTIVE INVESTORS ARE HEREBY NOTIFIED THAT: (A) ANY DISCUSSION OF U.S. FEDERAL TAX ISSUES CONTAINED OR REFERRED TO IN THIS DOCUMENT IS NOT INTENDED OR WRITTEN TO BE USED, AND CANNOT BE USED, BY PROSPECTIVE INVESTORS FOR THE PURPOSE OF AVOIDING PENALTIES THAT MAY BE IMPOSED ON THEM UNDER THE U.S. FEDERAL TAX LAWS; (B) SUCH DISCUSSION IS WRITTEN TO SUPPORT THE PROMOTION OR MARKETING BY THE COMPANY OF THE TRANSACTIONS OR MATTERS ADDRESSED HEREIN; AND (C) PROSPECTIVE INVESTORS SHOULD SEEK ADVICE BASED ON THEIR PARTICULAR CIRCUMSTANCES FROM AN INDEPENDENT TAX ADVISOR.
I hope you find this helpful!
The short answer is its going to be a complicated mess, if you are an active crowdfunding investor. Every deal is different and every state is different. For a lot of deals you will have to file and pay state taxes in the state that you made the investment. I done over 30 CF deals this year. I was a cpa with an MBA in finance and I know April of 2015 is going to be a pain in the A$$.
My understanding is no one is an active investor hence, you are passive investor and only pay taxes in the state you reside in on the interest you earn on the investment. Like a bond. I have MBA in Finance with international and domestic experience as well as several active and passive investments in several states.
@Todd Michael I had the same question and directed it to RealtyMogul where I have a couple of investments. This is what the response - For equity transactions you'll receive a federal K1 and state K1(s) for any state in which there is a state tax requirement (i.e., if you invest in a TX equity opportunity you will not receive a state K1 because TX has no state tax). For the MHP investment ( mobile park home fund) you may receive K1s from several different states - it depends on where they invest.
For debt transactions you'll receive one 1099 aggregating your debt investments together. Hope this helps.. I know my accountant is not going to be happy with me.. but if that's what it takes to make money.. so be it!
Boy, hadn't considered some of that. Thanks for the great info.
It makes sense to me that I would be a passive investor in these crowdfunding deals and thus should only be taxed in my state of residence.
I didn't ask my initial question very well. I am trying to determine if I can garner any tax advantages if I source from a taxable account. For instance, on an equity deal, will I have an opportunity to apply depreciation against my income? If so, are the numbers available on the K1 to calc depreciation? If this is a dumb question, please call me out.
And I can confirm that Patch of Land also issues one single 1099 aggregating the debt investments together. We do not deal in equity transactions and so, unfortunately, I cannot help out on that side of things (not even from experience). Maybe @Scott L. can provide some insight?
@Todd Michael I am hoping to garner some depreciation on the K1's for tax advantages on the equity deals. I've only done deals in 2014, so waiting for filing to see what happens. Maybe somebody can speak from past experience on this.
Great thread - Very interested in this discussion. Perhaps @Steven Hamilton II
has some views?
Much of this depends upon if they are receiving a benefit for their contribution. If they are it is taxed as income with no question. if they are not it becomes a blurry line.
@Todd Michael you should consult your tax advisor. My understanding and experience is that you will receive a K-1 for the State you have the investment in and then need to file a tax return for that state (assuming that state has an income tax). You will then receive a credit for the taxes you paid out of state on your state income taxes (at least in CA you will).
@ Matt Mason is correct. What many investors don't realize is that they will generally be taxed in the states in which the real estate crowdfunding entity owns property. In an equity deal, when a partnership actively conducts business activities or has “source” income in a specific state, that state will generally tax the individual partners based on the flow through income.
So just because you are a passive investor does not mean that you are only taxed in your state of residence. It does not matter what state the partners reside in, but they will often get a state tax credit from their state of residence that will help avoid double taxation.
@David Nusz You will certainly benefit from depreciation expense. Most real estate crowdfunding entities operate under a "tiered" partnership structure. There is a "holding" LLC that actually acquires and manages the real estate and the crowdfunding investors establish an LLC that becomes a partner to the holding LLC.
Depreciation is recorded at the holding company level, which will of course reduce any taxable income that passes down to the crowdfund investors. So when you get your K1 at the end of the year the depreciation has already been recorded. Hope this makes sense.
Create Lasting Wealth Through Real Estate
Join the millions of people achieving financial freedom through the power of real estate investing