We hear about the wealthy of America paying low or ZERO taxes.
Is it a myth, or does it really happen?
If it is in fact a truth, how does it even happen?
It is almost the time of the year when people will start consolidating last year’s earnings and start dreading taxes. This is also a good time to start planning for the tax savings strategies for your cash flow this year, so you can extend the value of your dollar.
Today, we will shed some light on the strategy behind the ZERO tax equation based on a scenario of investing in multifamily syndications, and at the same time discuss how this investing model can provide you, a passive investor, a multi-layer tax advantage reducing your tax liability.
Continue reading to find out how, where we explain this complex topic in simple terms with examples and number breakdown.
Passive Investor Tax Perspective: Why Invest in Syndicated RE Investments?
While investing in rental RE provides you some advantages, a syndicated Real Estate investment provides you an even better write-off, even as a passive investor.
Here is why you should think about investing in syndicated investments:
- Passive cash flow
- Capital preservation and equity gain
- TAX benefits
Today we will focus on TAX benefits, available via depreciation, combined with the Tax Cuts and Jobs Act, 2017 that provides multiple tax benefits in a syndicated investment.
Mentioned below are the three ways through which an investment like Multifamily Syndicated RE can save you on Taxes:
1. Depreciation-
If you have invested in rental real estate, you might be familiar with depreciation.
Depreciation is the process used to deduct the costs of a RE property. Rather than taking one large deduction in the year, you buy the property; depreciation distributes the deduction across the life of the property.
According to the tax laws residential real estate is considered to depreciate in 27.5 years (39 for commercial) as straight-line depreciation.
This calculation provides you a paper loss or writes off against your rental income that can be deducted from your income, reducing the tax liability.
Seems complicated?
Let me explain this with an example:
Let’s compare a single-family home worth $300K and an apartment complex worth $1M. Let’s calculate the straight-line depreciation.
Note: When calculating depreciation, you can consider only the structure value, not the land value.
How it is calculated:
| Single-Family | Multi-Family |
|---|---|
| Example: $300K Purchase | Example: $1M Purchase |
| Say $45K is land $255K is the Structure value (15% land) | Say $150K Land and $850K is the Structure value (15% land) |
| $255,000/27.5= $9272 per year depreciation | $850,000/27.5 = $30,909 per year depreciation |
So, if your cash flow for this single-family home is $10K, you will be taxed on $10,000 – $9,272 = $728.
So, if you were at the 28% tax bracket, which will save you $2,072 in taxes
(you will be paying just 7.28% in taxes on this rental income).
This is why, when it comes to real estate investing, depreciation is one of the biggest tax benefits which passive investors enjoy.However, when you are part of Syndicated Commercial Real Estate projects, even as a passive investor, you enjoy an additional two-fold tax benefit compared to single-family rentals.
2. Cost Segregation-
Cost Segregation is a powerful tool for saving taxes in Real Estate investments.
Any individual or company who has constructed, expanded, purchased, or remodeled any kind of real estate property to increase cash flow can take this advantage.
Cost Segregation allows them to take the depreciation or passive losses on more than just the structure, here is how:
Interior Assets: Depreciated faster, over 5 Years: Carpet, Ceiling Fan, Appliance, Leasing Office/Laundry interiors, etc.
Outside Assets: Depreciated over 15 years: Pool, Playground Equipment, Camera, Tennis Court, etc.
Structure: 27.5 years: Roof, Foundation, etc.
Cost segregation is performed as an additional study where the above costs are broken down and detailed so additional depreciation can be applied faster than 27.5 years.
Note: Due to the cost of this study, it’s not feasible to be performed on a single-family home but can be easily done for a real estate investment like syndicated apartment/multifamily investments.
3. Bonus Depreciation-
But wait, the benefit does not stop at the faster depreciation on additional assets, Bonus Depreciation stretches the benefit even further to allow you to take ALL that depreciation in the first year itself.
How? You may ask!!!
Bonus Depreciation Provision was one of the major changes that came along with the Tax Cuts and Jobs Act of 2017.
According to this act, on a property purchased after September 27th, 2017, a business can take 100% bonus depreciation in the first year itself.
Because of bonus depreciation, people will be able to deduct roughly about 25% of the buying price of the building in the first year.
For example, if the building was purchased at $1M, investors can deduct roughly about $250,000 in the first year alone.
So, if the investors invested $300,000 as a down payment + rehab budget, they will be able to take $250,000 as paper loss/depreciation, that’s almost 80% write-off.
Simply put, if you are a passive investor, investing $50,000 in this investment, receiving $8K cash flow per year. You will get passive losses of about $41K. You can apply that on your $8K cash-flow, reducing your tax liability, carrying forward the reminder of losses into the next year, till you use it all up.
This can be considered as a huge impact on what shows up on your K-1.
Please note this is not an actual loss, but just the way to consider that these assets will lose value over the period as they get older. You still would have positive cash flow.
CONCLUSION :
In summary here is how depreciation, cost segregation, and bonus depreciation strategy can be combined together as follows:
- Straight-line depreciation for 27.5 years
- Strategy: Rehab in 1-2 years and sale within 5 years
- Accelerate the depreciation on internal, external, and rehabbed assets, instead of waiting 27.5 years (with cost segregation)
- Take bonus depreciation in year 1 or 2 after rehab.
- Take advantage of paper loss on increased income and gain on sale
- Increase Cash flow and reduce Tax Liability
Multifamily Syndications are a great tax-efficient investment vehicle. If you want to pocket more from your income cash flow or avoid paying taxes, the IRS has provided multiple ways to do that through Commercial Real Estate investment, such as multifamily syndication, presented in the form of depreciation, cost segregation, and accelerated depreciation opportunities.
Now if your W2 income is about $200K, and you have about $180K of such losses from multiple investments, and you or your spouse qualify as a Real Estate Professional, you would be able to reduce this from your income, paying taxes on just $20K, which is less than standard deduction if filing jointly, making your TAX liability, yes you guessed it right ZERO!
Even if you are not there yet, if you or your spouse decides to become more active in Real Estate investments, you can even start carving your path towards a low or ZERO-dollar tax bill.
Now, this tax law is not here to stay forever, after Jan 2023, the advantage of Bonus Depreciation where you can take all these benefits in the first year starts to go down and vanishes after 2027, so make use of it while it is still available.
Contact us to find out how you can invest in these tax-advantaged Commercial Real Estate, such as multifamily real estate investments, and start cutting back your 2021 tax bill.
Please Note: All the points mentioned above are just summaries and not advice or recommendation. Please consider consulting with a tax professional regarding your investment situation and tax to learn in detail about the application of these strategies. If you depreciate a rental real estate, some depreciation recapture is applied on the sale of that asset, which can be further mitigated using multiple strategies, just reach us and ask how.