Tax Benefits of Real Estate Syndication Part 2
This is part 2 of a 2 part article. Please refer back to Tax Benefits of Real Estate Syndication Part 1
As a recap, 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.
4 More Tax Advantages of Real Estate Syndication
1. The Long-Term Capital Gains Tax Rate
Most of the syndications put together by our team are long-term investments. In the private equity world, “long-term” means one year or longer. Usually, we’re talking about anywhere from three to five years.
Something special happens in the tax code when you hold an investment for longer than a year — the long-term capital gains tax rate kicks in. That is to say, when we sell the asset and payout proceeds from the sale to the investor group, any profits over and above the initial investment are taxed at this long-term rate.
What is notable about this tax rate? Most importantly, it is lower than the short-term capital gains rate … which is essentially the same as the ordinary income rate. Short-term capital gains, under the current tax code, can range anywhere from 10% at the lowest income bracket to 37% at the highest.
How much lower is the long-term capital gains tax rate? It’s a flat 15%. For most investors, this is a highly advantageous tax rate to take advantage of.
2. No Payroll Taxes
Of course, the long-term capital gains tax rate only applies to the windfall appreciation that we harvest when we sell the property after holding it for more than a year. Cash flow is taxed at the ordinary income rate — that is, whatever is left after the deductions.
But even if you can’t write off all the cash flow with depreciation and the QBI deduction, there is one more tax you get to avoid as a real estate investor — payroll taxes. Both W2 and self-employment income are usually subject to FICA taxes, but the cash flow you receive from a real estate syndication is exempt.
3. Tax-Deferral Incentives
The tax code contains several opportunities to use real estate investments to defer taxes. One of the most famous of these is the 1031 exchange. This allows you to flip your profits from the sale of a real estate investment into another, larger property and perpetually defer those taxable capital gains as long as you keep moving it into bigger and bigger properties (with more and more cash flow all the way).
Unfortunately, the 1031 exchange isn’t usually a viable option for a real estate syndication. It would require the entire investor group to move their assets into another property which is difficult to do.
One tax-deferral incentive that is available to syndication groups is the Opportunity Zone incentive, based on a Federal law that designated certain low-income neighborhoods as “Opportunity Zones” and offers tax-deferral benefits to attract investment dollars to that area. Multifamily syndications in opportunity zones can defer taxes for as long as ten years.
4. IRA Eligible
While syndications aren’t great for 1031 exchanges, what they are good for is retirement accounts.
Yes, you can invest IRA and 401(k) funds in real estate syndications. Don’t ever let a money manager tell you it’s “impossible.” It’s totally legal and very easy. You just need a self-directed IRA or solo 401(k).
In fact, syndications align well for retirement accounts. The law requires that you be a passive investor with assets held in the name of IRAs and 401(k)s … which is exactly what you are as a passive investor in a real estate syndication. To clarify, you could not use your IRA to buy a property that you manage. That would be in direct violation of the rules and expose your IRA to penalties. It must be a passive investment.
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.