Real estate investing is a lucrative business, but it’s crucial to understand taxes. As a passive investor in a real estate syndication, your sponsor team will guide you through tax season and ensure you receive the tax benefits you deserve. Real estate investments lower your tax obligation, unlike other investment vehicles like mutual funds and stocks. Therefore, it’s essential to do your due diligence to understand your tax obligations and explore the best strategies to reduce your tax bill. This article provides an overview of the best tax strategies and how to maximize the tax advantages available to real estate syndication investors.
Deciding On Your Entity Election
Real estate investors often inquire about the impact of setting up their entity on their tax deductions. The tax deductions remain the same regardless of the entity type, including all business-related expenses. It is advisable to avoid electing C-corporations as they can tax all earnings multiple times. To simplify the process, it is recommended to form a single-member LLC. Most real estate syndications are formed as multi-member LLCs and are taxed as partnerships. To ensure asset protection, maintain separate business and personal accounts and avoid intermingling funds. During the startup phase, any costs incurred, including legal fees, research, travel, and professional fees, are tax-deductible. This helps protect the integrity of your business entity.
Taxes And Real Estate Syndications
Real estate syndications are typically limited liability companies (LLCs) with investors as the limited partners. The lead syndicator acts as the general partner, while the investors are the limited partners. The syndication is not taxed, as it is a pass-through entity, with income, expenses, gains, and losses passed on to the limited partners. Each syndication member is liable for specific items on the K-1, which are taxed accordingly. Cash distributions received as returns on investment are tax-free up to the extent of the tax basis in the syndication. The tax basis is the initial capital investment into the deal, which can fluctuate annually. Cash distributions are tax-free as long as the tax basis remains positive, and excess distributions are taxed as dividends. Lead syndicators have flexibility in allocating items, and the real estate syndication operating agreement can reflect these allocations based on the partners’ personal needs.
Taxes And Rental Real Estate
As a limited partner in a syndication, you earn passive income, which can offset passive losses. A special allowance for rental losses is available for married couples with an adjusted gross income of $150,000 or less. However, higher adjusted gross incomes cannot be used to offset passive losses. Real estate professionals have a special designation that allows them to take more passive losses against their earned income. To qualify, they must meet three parameters: 51% of their working time and services must be in real estate-related activity, they must work more than 750 hours in a rental real estate trader business in a calendar year, and they must materially participate in their business’s real estate activities. This can include rental property management, syndication deal sourcing, and brokering properties. It is important to discuss your personal situation with a CPA as changes can impact your tax situation, so seek professional advice from a CPA or tax advisor.
The Power Of Depreciation And Cost Segregation
Depreciation on property is expected over time, allowing investors to write off the depreciated value over time. Residential rental assets can be written off for 27.5 years, while commercial properties can be written off for 39 years. Cash-on-cash returns defer tax on earnings, allowing investors to pay taxes until the asset is sold. Bonus depreciation can further maximize tax benefits. Cost segregation can further increase tax advantages by considering various aspects of the property that depreciate at a quicker rate. For example, signage in an apartment complex depreciates faster than the roof, allowing investors to have further tax advantages even within five years. Overall, depreciation can provide investors with significant tax benefits.
Tax Benefits Of Investing In Real Estate
Real estate investments offer significant tax advantages, allowing deductions to offset income and reduce tax bills. To build wealth, strategies must be used to maximize tax benefits. Real estate syndications provide a quick and sustainable way to build wealth while mitigating risk. Regular people can build wealth through these strategies, ensuring a balanced financial future.