All Forum Posts by: Daniel Han

It's very confusing. As far as I can find

1. passive losses can't be used to offset depreciation recapture

2. you can fully deduct suspended passive loss from the profit when you sell your rental property - you must sell the entire property and must be taxable event - recognize income or loss, sold to non-related party

3. you can't use it to offset the capital gain

I guess the question is if your MF syndication is sold, is the profit "capital gain"? or another passive income as a LP?

in my original example, is preferred return distribution passive income but profit from the sale capital gain?

@Brian Burke

@Basit Siddiqi  In what cases can you offset the capital gain of the first deal using the paper loss of the 2nd deal? I thought all income and loss from syndication LP investment is passive income/loss. so all previous loss adds up and offsets any future passive income?

Just trying to make sure I understand correctly the benefit and tax consequences of multi-family syndication investments.

Let's say you invest in a hypothetical syndication deal as a LP, ~20% IRR (2.5x multiple), 7% Preferred Return, Cash flowing from year 1, and exit in 5 years.

and let's assume the sponsor executes perfectly to the plan. and you invest $100k in the deal. The number is made up to make the calculation easier in my head.

Also, assume the first-year tax loss due to depreciation (cost segregation, bonus, accelerated) is 50% of the investment.

In the case above, you have roughly

1. $7k per year preferred return distribution times 5 years = $35k

2. $50k K1 loss

3. no tax on distribution during the entire 5 years because of $50k loss.

4. at the time of sales, you still have $20k loss left

5. at the sales (~2.5 times multiple), you get ~$200k back ($100k original capital + ~$100k profit).

6. you owe IRS capital gain for $80k + recapture of depreciation, depending on your income, up to 20%.

If you don't do anything, then you pay IRS long-term capital gains tax and it's all done.

However, if you invest all the proceed of $200k in the same calendar year on a deal with the same terms, then you generate $100k paper loss effectively offsetting capital gains tax from the first deal.

It seems like you will eventually run out of paper loss unless you put additional money in. however, you can defer the tax quite a bit.

You can continue to do this until you die.... when you go, your kids will get this tax-deferred investment on a stepped-up basis wiping out the tax liability.

Am I understanding it correctly?  What am I missing?

@Brian Burke @Kurt Granroth  Great discussion and I'm learning a lot from it. Kurt might be looking at the same PPM I have.

In this particular PPM, it states

Series A Preferred Units (“Series A Preferred Units”) and Series B Preferred Units
(“Series B Preferred Units,” and collectively with the Series A Preferred Units, the “Preferred Units”
or “Units”)

I read it as both A/B are holders of Preferred Units.

The wording seems to be capital is returned pro-rata. so when things go bad, both class A and B investors would lose capital proportionally. so class A is not as protected as you might think.

so in that case, why would you want to invest in class A? My guess is that there is no other place that yields 10%. There seems to be demand for this consistent income stream. I can understand it can be very attractive.

As long as the deal doesn't lose initial capital at the end, class A could make it out with 10% return.... while class B could end up with 0% return. 

I think what @John Sayers noted is important. If you have a property and present it in 2 separate structures (traditional vs A/B). The overall return should look better for the A/B structure since B returns are quoted in the documents.

The need for the A/B might be an indication that it's getting harder to match the return projections of the previous offerings that investors are used to.

The problem statement from @Kurt Granroth is "my return is potentially compromised compared to a deal that did not have such a split".

The issue is finding a comparable deal from an equally qualified sponsor, similar return projection, and from the same market. If you do, there is no need to take on the additional risk of being a B investor. I fully agree with the problem statement.

in my mind, these 2 deals would be about the same in terms of risk/reward for me.

1. vetted sponsor 1, in market A, no A/B structure, X% IRR

2. vetted sponsor 2, in market A, A/B structure, X+2/3% IRR

I have been trying to figure this out as well. 

I look at it in a simplistic way. 

Let's assume (a big one), that the syndication deal goes as just planned. Many syndicators target 13-18% IRR... say 15% without class A/B structure.

but if you implement class A/B on that same deal, essentially, you take 5% (I don't think the math works like that, but conceptually you get it) from class A investors to class B investors + sponsors. Depending on the percentage of investors in class A or class B, class B would get a higher return than the deal without A/B structure.

In this case, why would you not want to invest in class B? especially when the preferred return is accrued so eventually your preferred return will catch up?

I think it comes down to

1. do you trust the sponsor to hit the target returns?

2. is the market condition such that there is a higher risk of the deal not performing?

3. do you need regular distribution?

4. are you willing to take the risk for potential upside?

To me, these questions apply to any investment. 

If I assume the sponsor will deliver the result as promised and the market will be good next 5 years. I would say you have to invest in class B unless you need the distribution.

If I assume the sponsor will not deliver the result, then I probably will be investing in neither class A nor B.

If I assume the sponsor is good but an uncertain market is ahead, then something to think about. Maybe class A is a safer bet. what other investment pays 10% these days?

Not a CPA. 

My understanding is syndication would be considered passive income and considered differently than capital gain. You can't offset your stock gain with passive loss from the syndication.

In general, you can't deduct RE expenses from your W2 income unless you or your spouse is a real estate professional.  so most people can't deduct RE expenses from W2 income.

I researched before to reduce W2 income. The requirement is strict. @Jonathan Stone You might want to be careful. Working in RE industry doesn't qualify you as RE professional. You have to work a certain number of hours for your properties to be qualified. There are enough horror stories IRS auditing hours being worked on your properties.

I guess there is scrutiny because it's a very popular method to archive large deduction for high income W2 earners.

@Joe Binkowski - this seems overly complicated and possibly breaking a law... maybe you need a lawyer to vet this.

If I were that accredited investor, I wouldn't touch any of it. There is no such thing as risk-free money.

"small portion" of profit is not worth the possible legal issues.

the question is confusing to me.

are you referring to taking funds from an investor and then putting it into a known syndicator's deal? and you split the return?

or becoming a syndicator yourself?

or have an accredited investor invest in the syndicator's deal with your money? and split the difference?