Commercial Real Estate Syndication - Attractive Tax Benefits (4 min)
In March of every year our accountants are working hard to get our Schedule K1 Partnership forms to our investors. The K1 provides the tax accounting on the asset's prior year of operations. One of the best things about investing in commercial real estate syndications are the tax benefits. Investors see this very clearly when they open their K1 statements and usually experience a paper loss.
I have some investors call me when they receive their statements and wonder if everything is sound with their underlying investment. I tell them that the Schedule K1 is for tax reporting purposes and we are excited when we see losses. The passive losses can be used to offset passive gains in other areas of their portfolio. It has no direct relationship to the health of the underlying asset.
Some of the most common deductions are:
Property Taxes
Interest on the property loan
Depreciation on the property
As a limited partner, the investor gets to share in these deductions based on their proportional ownership interest in the overall limited partnership. These deductions make investing in commercial real estate assets very tax efficient.
Depreciation:
Depreciation is often accelerated. Through a cost segregation study, a determination can be made to accelerate certain aspects of the asset to say 7 years for a commercial building that normally may be 27.5 years straight line. As a result, we might see significant deductions in the early years of the asset. On the flip side, there is some recapture tax that may occur when the property is sold.
Refinances:
It’s common for value-add syndicators to optimize the value of a property (i.e. an apartment) over say two years and once renovations are completed (higher rents might be achieved), go to the bank and refinance the property, if the value increased, and pull equity out. There is typically no taxable event when you return a portion of an investor’s original principal.
1031 Exchanges:
A 1031 exchange allows one to swap a like kind property for another like kind property and defer the capital gains tax on the sale of the first property. Most syndications are not setup to take in a 1031 exchange from an investor’s personal property. Nor if they are invested in our syndications at sale, take the sale proceeds and 1031 into another investment property they may want to buy for their own portfolio. However, I have been involved in several 1031 exchanges from one syndication deal to another syndication deal under the same sponsor. That is workable and may be highly beneficial to investors.
Self-Directed IRAs / Solo 401k’s:
Investing with your self – directed IRA and solo 401K’s. If these real estate investments are so tax efficient, why then are folks investing w/their IRAs and solo 401K’s and not just their savings, isn’t that redundant? Simply put, there is a lot of money sitting in these qualified retirement plans and some investors are interested in diversifying into assets like real estate.
That said, there is a UBIT (Unrealized Business Income Tax) that is in play. UBIT is a tax on the profits of the leveraged portion of the asset.
UBIT is to be reported by the syndication on your Schedule K1. This seems to impact SD-IRA account holders and not solo 401k holders. So, if you have a choice, since investing in real estate can be tax efficient, using your regular savings money (aka - post tax dollars) may be the most attractive way to go. Since Solo 401K’s are not subject to UBIT, that can be another tax efficient option.
Even though SD-IRAs can be subject to UBIT it might be worth considering when evaluating funding sources for real estate.
UBIT rules are complex and may change. You should always consult with a tax professional for current regulations.
Syndication commercial real estate properties can be tax efficient.
From the standard property tax, loan interest and accelerated depreciation opportunities to refinances, potential 1031 exchanges and qualified plans, the IRS currently has provided ample ways to optimize for your tax situation.
These are brief summaries and not a recommendation or advice. Please consult with a tax professional regarding your tax and real estate investment situation to learn more about these strategies and how they may apply to you.
*This article is for informational purposes only and does not constitute tax or investment advice.Tax benefits may vary depending on individual circumstances. Changes in tax laws and economic factors can affect real estate investments so consult a tax professional for personalized advice. Tax laws and regulations are subject to change. Information provided is current as of Feb 2023. Real estate investing comes with a variety of risks including rising interest rates, lower than expected occupancy and the operator’s failure to execute the renovation and rental increase business plan. Real estate investments are also illiquid which means there is no readily available market for an investor to sell their interest in a real estate syndication. Investors are also typically required to be deemed an accredited investor. As with any investment, there is the risk the entire investment may be lost.