Unlocking Tax Savings for Real Estate Investors: A Guide to Maximizing Your Investments

by | Jul 13, 2023 | Real Estate Syndications

While the intricate dance of numbers associated with taxes may not get your heart racing, their importance in the realm of real estate investment is undeniable. As you revel in the thrill of profitable returns and the lifestyle upgrades that accompany it, we at GrowAbility Equity would like to encourage you to take a glance at the not-so-glamorous tax side of things.

As a passive investor riding the wave of real estate syndication, you can rely on your sponsor team to usher you through the complexities of the tax season. The silver lining of investing in real estate lies in its potential to reduce your tax obligations, a striking contrast to other investment platforms like mutual funds or stocks which may surge it.

Putting your hard-earned money into the fray of the investment world warrants a meticulous due diligence process. Arm yourself with a practical understanding of the potential tax implications of your investment and devise strategies to shave off some dollars from your tax bill. Read on for a concise briefing on top-tier tax strategies and how you can extract the maximum tax benefits as a real estate syndication investor.

In Your Name, A Partnership or A Corporation: The ABCs of Entity Elections

A common query from real estate investors revolves around the impact of their entity setup on tax deductions. Whether you invest under your personal name and social security number, operate a single-member LLC, or run a multi-member LLC or corporation, your entitlement to tax deductions remains consistent. The deductions encompass all business-related expenses.

Setting up your real estate investment business under a C-corporation, however, isn’t recommended. This could subject your earnings to multiple rounds of taxation. If you’re new to this game, consider forming a single-member LLC for simplicity. Real estate syndications typically operate as multi-member LLCs, with taxation resembling that of partnerships where income and expenses are shared among partners.

To truly harness your tax benefits, strive for a clear separation of personal and business assets. This includes maintaining distinct personal and business accounts and preventing any cross-contamination of funds. This helps preserve the integrity of your business entity and protect your tax savings in the event Uncle Sam and his audit team ever come calling!

Remember, you can deduct costs incurred during the startup phase of your business, even before finalizing your entity type. These expenses range from legal fees to research costs, travel expenses for property visits, and other professional fees.

 Real Estate Syndications and Taxes: The Inside Story

Real estate syndications often function as limited liability companies (LLCs), with taxation akin to a partnership. The lead syndicator (or sponsor) team dons the role of the general partner, while the investors are the limited partners.

Interestingly, the real estate syndication itself isn’t taxed. Instead, it operates as a pass-through entity, where income, expenses, gains, and losses are transferred to the general and limited partners based on their percentage ownership. Each investor is liable for taxes on the items separately listed on their K-1 (a K-1 is the tax document that shows investor gains and losses and is included as part of the investor’s year-end tax filing).

The cash returns you receive from your investment aren’t typically subject to tax because they are treated as distribution of your investment principal or more precisely, your tax basis.. Essentially, your tax basis equals your initial capital investment, plus current year contributions and income, and minus any losses and expenses. This basis will fluctuate annually. As long as your tax basis remains positive, your cash distributions are tax-free. Excess cash distributions (i.e., after the tax basis goes to zero) are taxable as dividends but can be partially or totally offset by depreciation.

Lead syndicators can choose how to allocate various items, and the operating agreement of the real estate syndication can be adjusted to suit the individual needs of the partners.

Tax Implications for Rental Real Estate

As a limited partner in a syndication, your earnings qualify as passive income. Passive losses and earned income, or W-2 income, are treated differently. Passive income is classified in the same bracket as interest dividends, with passive losses typically offsetting passive income.

Special provisions apply to rental losses. As a general rule, passive losses from real estate (driven by the depreciation deduction) can only be used to offset passive income. However, you can become a real estate professional to be positioned to now be able to claim rental passive losses against earned income as well!

Being labeled as a real estate professional (REP)requires meeting certain criteria established by the IRS. A minimum of 51% of the investor’s working time and services must be invested in real estate-related activities. Furthermore, the investor must clock in more than 750 hours in a rental real estate trade or business within a calendar year. Material participation in the business’s real estate activities is also necessary. This benefit – the ability to become a REP – is major — one that has allowed Willie and me (and countless other REPs) to cut our taxes virtually to zero (legally and ethically) because we just did what Uncle Sam wants — be real estate entrepreneurs who will acquire, improve and modernize housing for our communities.

Elevate Your Tax Game with Depreciation and Cost Segregation

Depreciation is your friend…this is THE main reason real estate is such a great tax saver! As properties age, you are allowed to deduct the depreciated value of the asset over time – 27.5 years for residential rentals and 39 years for commercial properties. The depreciation deduction reduces your taxes and these taxes, in theory, are to be used to improve the property as it wears down over time.

Practically though, depreciation acts as a boon for investors. Why? Because for a good operator, all of those tax savings don’t need to be reinvested in the property, some can be shared with investors to increase their returns via tax savings in addition to cash returns. The option of bonus depreciation is available, further amplifying your tax benefits.

To further amplify returns, syndicators also pursue bonus depreciation and cost segregation. These are more advanced moves that enable the property to be depreciated faster, allowing you to speed up depreciation benefits and maximize tax advantages.

Sprouting Wealth through Real Estate: The Tax Advantage

Through active or passive investment in real estate, you can tap into an array of tax advantages. Deductions accrued from real estate investments can be utilized to offset other income streams, significantly trimming your annual tax bill.

Yes, wealth building extends beyond income generation. It involves an intimate understanding of strategies that maximize the tax benefits available to you. Investing in real estate syndications unlocks the potential for rapid and sustainable wealth creation, while mitigating risks.

Always touch base with your CPA or tax advisor to evaluate your unique circumstances and pinpoint the strategies that align with your financial aspirations. Lastly, whether you want to learn more about how to save taxes investing in real estate or are ready to get started, schedule a wealth acceleration call with us at Growability. You can also join the GrowAbility Equity Club to stay updated on the latest investment opportunities.

Thanks for being a part of our community. Until next time, keep growing your ability to accelerate your wealth and legacy building….glad to be a part of this journey!