For many individuals, tax season can be an overwhelming and stressful time. However, for those who are actively involved in multifamily real estate investing, specifically through real estate syndications, tax season can actually bring excitement. This is because multifamily syndications offer numerous tax benefits and incentives for passive investors, allowing them to maximize their profits from this investment stream.
In addition to providing a lucrative passive income stream, investing in multifamily syndications is also one of the most tax-favored investment avenues available. However, it is important to note that the information provided in this article is based solely on our experience and understanding, and should not be construed as tax advice. It is highly recommended that investors consult with a qualified CPA for advice on their specific situation.
Outlined below are some of the top multifamily syndication tax benefits that every investor should be aware of, in order to fully capitalize on their investment opportunities.
One of the most significant but often overlooked tax deductions in real estate syndication is depreciation. Depreciation is an accounting method that calculates the decline in value of tangible business assets over time, allowing owners to write off the cost. The most commonly used method of depreciation is straight-line depreciation, which divides the annual deduction cost of an item by its useful life.
In terms of real estate, the IRS has determined that the useful life of residential properties is 27.5 years, while commercial properties have a useful life of 39 years. For instance, if a property is valued at $1 million, the annual depreciation deduction would be approximately $36,000. This means that an investor can deduct $36,000 in depreciation each year for up to 27.5 years.
The significance of this deduction lies in the fact that, hypothetically, an investor who makes $10,000 in profit in a year on their invested property does not have to pay taxes on that amount and can keep it completely tax-free. While on paper it may seem like they lost $26,000, in reality, they earned $10,000. It is important to note that investors should consult with a qualified CPA to determine their specific tax situation and the potential benefits of depreciation.
Cost segregation is a tax strategy that is similar to depreciation but accelerated. Unlike traditional depreciation, cost segregation takes into account that some parts of a property may depreciate much faster than the standard useful life of 27.5 years for residential properties or 39 years for commercial properties. For example, flooring such as carpet has a much shorter lifespan.
By hiring an engineer to conduct a cost segregation study, individual elements of a property can be evaluated, and their lifespan calculated. This allows investors to depreciate many items over a much shorter timeframe, such as 5-15 years. Taking depreciation deductions at a faster rate can provide significant tax benefits, especially for investors with shorter hold times.
In most multifamily real estate syndications, the typical hold time is around 5 years. This means that investors may only get 5 years of the depreciation benefits listed above (out of 27.5 or 39 years), resulting in missing out on over 22 years of depreciation benefits. By being able to take a larger depreciation deduction earlier, investors can benefit more from the depreciation benefits and make a higher profit.
When a property is sold, capital gains tax is owed, and in some cases, depreciation recapture. Another depreciation option, resulting from new tax bills, is called “bonus depreciation.” This allows investors to depreciate the entire value of a property in the first year, carrying forward losses until the property is sold, which can offset capital gains. It is recommended that investors consult with a qualified CPA to determine their specific tax situation and the potential benefits of cost segregation and bonus depreciation.
If you’re not ready to pay capital gains taxes on an investment property, a 1031 exchange could be a great option. A 1031 exchange allows investors to sell a property and reinvest the gains in a new property within a specified time frame. Essentially, you’re deferring the payment of capital gains taxes to a later date, while still maintaining your investment in real estate.
It’s important to note that not all real estate syndications offer a 1031 exchange option. So, if you’re considering this option, it’s important to do your research and ask about the availability of a 1031 exchange during the investment process. Additionally, it’s recommended to work with a qualified tax professional to ensure compliance with all IRS regulations and to maximize your tax benefits.
Refinancing and cash-outs are common practices among multifamily real estate investors. After investing in a property for 1-3 years and making renovations and rent increases to boost its value, investors can refinance the property and return a portion of their equity without incurring any tax obligations. This allows investors to access the increased equity and use it for other investments while continuing to reap the benefits of owning the property.
Additionally, real estate investors can benefit from the fact that rental income is not subject to social security tax or Medicare tax. This can add to the overall tax advantages of investing in multifamily real estate syndications.
To conclude, the tax advantages of multifamily real estate syndications make them an attractive investment option for those seeking to grow and safeguard their wealth. With the combination of significant tax benefits and impressive returns, real estate syndications can offer short and long-term gains. It is a tax-friendly way to convert your hard-earned capital into passive income, making it a prime avenue for any investor to consider.
