Tax Benefits of Real Estate Syndication Part 1
Why do people always refer to the tax benefits of real estate investing?
Because with every real estate investment, we have a secret, silent partner — a partner who wields immense power, and who puts that power to use to pad our bottom line.
That partner is the IRS.
This is one of the key pillars of real estate investing — as real estate capitalists, US tax law is on our side. We talk about the “tax benefits of real estate investing” like we’re talking about tomorrow’s weather forecast, but there’s nothing blasé about them. It’s an insane advantage.
So yes, I want to strike a phenomenal deal every time … but the sad fact is that with the IRS so firmly on our side, investors often come out ahead even in a mediocre deal.
Best of all, this is especially true of the kind of real estate investing we do here at High Tech Freedom and Pacific Pine Property — commercial multifamily syndication.
3 Tax Advantages of Real Estate Syndication
We are not CPAs, and this is far from an exhaustive list, but here are the seven tax advantages of real estate syndication that we have leveraged with our multifamily real estate and syndication investments.
1. Deductible Expenses
If you’re a homeowner, you cannot deduct your water bill or your homeowner’s insurance from your W2 income at tax time.
The truth is that most W2 employees have very few expenses that can be successfully written off as tax deductions. Your mortgage interest is just about the only one.
By contrast, a real estate investment is eligible for a whole host of deductions — not just the mortgage interest, but also the insurance expense, property taxes, utilities, management expenses, payroll expense, repairs, … basically everything.
What does this mean for you as a passive investor? It means that those expenses have been paid for with pre-tax money. You only get taxed on the net rent proceeds handed over to you in the form of cash flow checks.
2. Deductible Depreciation
“Depreciation.” Is there anything more beautiful in real estate? We covered the magic of depreciation in this in-depth article, but we revisit the key points.
To recap, the IRS allows you to write off a certain portion of your cost basis (long story short, the purchase price of the property plus closing costs, minus the value of the land) as an expense for depreciation — depreciation meaning “wear and tear” on the property.
The thing is, “wear and tear” on the property don’t actually cost you any money. You might need to make repairs … but those repair expenses are deductible in their own right. So you can think of depreciation as a kind of “hidden expense” — it doesn’t cost you any money, but by writing it off at tax time you get to owe less money in taxes.
We all know that real estate tends to gain value with time, not lose value due to wear and tear as a car or an air conditioner does. If you end up selling the property for more than you paid for it (always the goal), you do have to “recapture” that depreciation … but there are ways to mitigate the amount you have to pay back.
Suffice it to say, every year you own a real estate investment, you get that extra tax deduction without paying any expense out of pocket. Homeowners don’t get to deduct a depreciation expense — only real estate investors. As a passive investor in a real estate syndication, you get to write off a portion of that depreciation on your own taxes, proportional to your percentage interest in the asset.
What about cost segregation?
With large commercial properties like the ones we syndicate at High Tech Freedom and Pacific Pine Property, it usually makes sense to hire an expert to perform what we call a cost segregation analysis.
A cost-segregation analysis enables us to take accelerated depreciation. This allows us to take much more depreciation in the first 5-7 years of the investment.
What does this mean for the passive investor? It means they often get a depreciation deduction that is much bigger than the cash flow they collect. At that point, they get to apply the deduction to the rest of their income — including their W2 for qualified individuals.
3. The “Pass-Through” Deduction
Passive investors in real estate syndications usually don’t own the real estate directly. They own a partial stake in a limited liability company (LLC), which owns the real estate.
Because an LLC is treated by the IRS as a “pass-through entity” (that is, income earned by the LLC passes through to the owners), income from the LLC is eligible for another nice deduction — the qualified business income (QBI) deduction.
What does this mean? You can deduct up to 20% of any “qualified business income” from a pass-through entity from your personal tax return.
Cash flow from syndication does count as QBI … so if you reaped $20,000 in cash flow from your portions of various syndication investments, you could be eligible to deduct another $4,000 from your taxes.
When you look at a deal memo for a real estate investment laying out the projected returns, you won’t see a line item for “tax savings.” We do a lot of projections to see if a real estate investment will be profitable, but the tax advantages are hard to project. Every investor’s tax situation is different, and we often don’t know the tax implications of our actions until after the fact.
The Tax Code is weighted so heavily in favor of real estate capital that our passive investors are almost always pleasantly surprised at tax time how advantageous their investment actually was.
We are not CPAs or tax attorneys. Everyone’s tax situation is different. Please be sure to consult your accountant/tax professional to confirm how an investment in syndication will impact you.
Check park in for Part 2 of this article to pick up 4 more tax benefits of passively investing in real estate.
Understanding the Distinction Between Asset Management and Property Management in Multifamily Real Estate