Investing in real estate through syndication is now one of the most efficient strategies to protect and build your income and personal wealth. There may also be substantial tax benefits associated with real estate investments made through syndication. Syndicated investing may be quite advantageous during tax season because of the unpredictable nature of prospective tax increases relating to your assets, income, and net worth each year.
You contribute to the funding of the real estate investment as a passive investor, or limited partner, in a real estate syndication investing arrangement. The money required to buy a large property is contributed by you and the other limited partners. All deal-related decisions are made by the general partner(s) or sponsor(s).
It is generally a sizable multi-unit property that the sponsor buys. The end goal is to make a profit when you sell this apartment block or condominium complex, which may require renovations. All of this activity is managed by the sponsor on behalf of each investment.
Both passive investors and the sponsor may receive substantial financial gains. And what makes this real estate investment (REI) syndication arrangement even more alluring are the considerable tax advantages and incentives they provide.
The IRS tax system is a collection of incentives designed to teach taxpayers how to utilize and invest their money wisely. Presently, passive real estate investment is highly subsidized.
The Best Tax Advantages of Investing in Passive Real Estate Through a Syndicate
The following are the most significant tax advantages of using a syndicate to make passive real estate investments:
- Depreciation of Real Estate
Taxpayers frequently forget to take advantage of the significant tax benefit for property depreciation that is permitted. Any investments you have in your portfolio may degrade with time. Because you are a passive investor, you are permitted to deduct the cost of your income-producing real estate based on the degree of wear and tear that it has sustained.
How to Calculate Property Depreciation Tax Deductions
Your investments in REI syndicated properties are depreciated using the following formula, which can result in significant tax deductions:
- Real Estate Value Before figuring out the worth of the land, one must first figure out the value of the actual structure or complex. In the following step, multiply the result by the property’s useful life. For a residential real estate investment, the IRS determines this amount to be 27.5 years, and for commercial real estates, such as a warehouse or storage facility, it is 39 years. This sum is deductible each year by the property investor.
For instance, multiply $700,000 by 27.5 to get the value of your apartment block or condo complex. Your annual tax deduction for 27.5 years will be $25,455, which is the sum of the previous two figures.
As a result, you may declare fewer profits each year and pay less in taxes to the IRS.
The majority of the time, if you depreciate property and report a loss on your tax return, you may only utilize that loss to offset passive gains made on other properties or investment kinds. If your modified adjusted gross income, however, is under $100,000, you are permitted to deduct $25,000 from your income.
However, if you report a significant loss, you must carry it over to the next year. A portion of your active revenue could be offset, as will be covered in a following subsections below.
- Bonus Depreciation. 2017 saw revisions to a few laws governing property depreciation as a result of tax cuts and the JOBS Act. These modifications made it possible for companies to deduct depreciation at an earlier stage of an investment property’s life. Additionally, the maximum deduction amount was increased.
You may deduct around 25% of the building’s purchase price in the first year thanks to bonus depreciation. For instance, if an enormous multifamily condo or apartment complex is bought in an REI syndicated investment agreement for $8 million, the passive investors can write off $2 million of that amount in the first year.
- Recapture of Depreciation When you sell your syndicated investment property, you must account for any earlier deductions. Nonetheless, the rate is still restricted at 25%, which is significantly higher than the maximum income tax bracket allowed. Furthermore, you have successfully postponed tax payments for several years.
Furthermore, you have successfully postponed tax payments for several years.
- Capital Gains
Taxable income includes capital gains, often known as earnings on the sale of an asset. However, compared to the rate for more conventional income, the tax rate on capital gains is different. Long-term capital gains are realized when you retain real estate investment income for more than a year. The rate of tax on this sum is capped at 20%, which is far lower than the 35 to 37 percent that the IRS would most likely levy on your day job pay.
Over time, compounding these profits might result in substantial tax advantages. Findings from this analysis show that taxes are not applied uniformly to all income. In comparison to your annual income from a day job, revenue from real estate investment through syndication is substantially more advantageous at tax time.
- Refinancing
You can borrow money without paying taxes when you refinance a syndicated investment property using the equity and appreciation that has grown. For instance, you might increase the rent if you spent $500,000 to buy an apartment building and spent that money renovating it.
The fact that this asset is now worth $1 million may be a result of improving market conditions. If you choose a cash-out refinancing, you can use $500,000 of this sum to purchase a different structure. Everything about this transaction is tax-free. You may utilize this money without incurring any additional tax obligations to expand and solidify your passive income sources.
- Deduction for Mortgage Interest Payments
As you are probably aware, a loan’s interest is paid in the majority of cases when payments are made early. These contributions are tax-deductible. A rental property’s interest payments can be deducted from taxes just like a conventional residential mortgage. If you’re a passive investor, especially in the first few years after purchasing a house, this can be a significant financial gain at tax time.
- Lost Opportunities
Your tax returns may show a net loss as a result of the deductions you made for buying and selling real estate and stock. Typically, these losses and deductions are only helpful for reducing other passive income. In this situation, you will get all distributions tax-free. You can roll over any losses you have if your losses are greater than your profits to balance out future passive income.
To include these losses as “active” revenue is a further alluring option. This may drastically lower your overall tax rate. Passive income, such as the proceeds from rental property, and active income, such as the pay from your regular employment, are significantly unlike in the eyes of the IRS.
Passive income losses may often only be used to reduce other passive income. You must report active losses to make up for any active income losses.
On the other hand, your whole passive real estate income and losses might be seen as active if you have Real Estate Professional Status (REPS). Once you’ve acquired REPS, you can utilize your real estate loss to lower your taxable income.
- Professional Real Estate Status
You can check the box to indicate that you are a real estate professional on your tax returns once you have earned that status. By doing this, the IRS will be able to consider your REI efforts as active rather than passive. Then, you may utilize your real estate losses to lower your yearly tax liability.
For the avoidance of doubt, real estate professional status is not the same as being a broker or realtor who has been granted license to work legally in the industry. To qualify for REPS, you must fulfill the two requirements listed below, which have nothing to do with a professional license or advanced education:
During the tax year, real estate trades or companies accounted for more than half of the services you individually rendered across all crafts or industries.
Throughout the tax year, you contributed more than 750 hours of labor to businesses or trades involving real estate.
But not everyone who makes passive investments as a limited partner in a real estate syndicate should pursue REPS. Consult your tax professional for expert information, advice, and direction.
Final Thoughts
Investing in real estate through syndication has many advantageous tax advantages. You may learn to benefit from tax advantages from your earnings and losses when you participate passively as a limited partner in a sizable multifamily real estate investment venture through a reputable REI syndicate.
You may significantly lower your yearly income tax payments by being aware of the IRS regulations for documenting your investment property depreciation, capital gains, refinancing, mortgage interest deductions, and losses carried forward. You may qualify for even bigger tax breaks if you and your tax advisor decide that obtaining Real Estate Professional Status (REPS) is the best option for you.
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