Multi-Family Syndication & Tax Depreciation

Multi-Family and Apartment Investing
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Multi-Family Syndication & Tax Depreciation

Scott Blackwill
Investor · Windsor, CO · Member since 2019 · 21 posts · 18 votes

Can someone explain to me how tax depreciation works as an LP? At what point do I actually pay taxes on my capital gains? Is it really just deferment and at some point I'll have to pay on all of it?  Seems like a too good to be true scenario. Doesn't the gov eventually recapture that year 1 depreciation because the sale of these properties is done fairly early (5 - 7 years)?  Layman's terms please!  I'm trying to explain to others why it's a great thing but I don't quite understand it yet myself.  Thanks!

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Nick B.
Investor · North Richland Hills, TX · Member since 2013 · 1k+ posts · 1k+ votes
6y

Depreciation is passed to the LP according to their %% of the ownership. E.g. if you own 1% of equity you get 1% of the depreciation of a given year. It reduces taxable income from the property and if that income becomes negative, it is subtracted from other passive income (other property that may have positive income) or ordinary income (if you make less than $100K or you are a real estate professional) or is carried over to the next year.

Once the property is sold, all previous depreciation becomes a subject to recapture - it is added to the income and taxed at a special rate (20% or so - ask your CPA). Capital gains are taxed after the sale at the long term capital gain rate. However, if you have excess depreciation from other properties that excess depreciation is applied to the capital gains making them tax deferred.

Ultimately, your taxes (long term capital gains + recapture depreciation) are due in full when all your properties are sold.

However, if you keep reinvesting you can effectively defer taxes forever similar to 1031.


DISCLAIMER: I am not a CPA and this in not a tax advice. I am an LP investor though and I've been through a full deal cycle.

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  • Michael Le
    Developer · Houston, TX · Member since 2015 · 1k+ posts · 1k+ votes
    6y

    As you mention, the recapture happens at the time of sale. If you refinance instead then you don't have to yet. When you recapture it will be at 25% rate which is likely lower than your income tax rate. So it's still very much worth it to do since you're delaying when you have to pay and you're paying at a lower rate. And if you happen to pick up another property the same year then you can offset those gains and kick the can down the road some more.

    4Reply
  • Nick B.
    Investor · North Richland Hills, TX · Member since 2013 · 1k+ posts · 1k+ votes
    6y

    Depreciation is passed to the LP according to their %% of the ownership. E.g. if you own 1% of equity you get 1% of the depreciation of a given year. It reduces taxable income from the property and if that income becomes negative, it is subtracted from other passive income (other property that may have positive income) or ordinary income (if you make less than $100K or you are a real estate professional) or is carried over to the next year.

    Once the property is sold, all previous depreciation becomes a subject to recapture - it is added to the income and taxed at a special rate (20% or so - ask your CPA). Capital gains are taxed after the sale at the long term capital gain rate. However, if you have excess depreciation from other properties that excess depreciation is applied to the capital gains making them tax deferred.

    Ultimately, your taxes (long term capital gains + recapture depreciation) are due in full when all your properties are sold.

    However, if you keep reinvesting you can effectively defer taxes forever similar to 1031.


    DISCLAIMER: I am not a CPA and this in not a tax advice. I am an LP investor though and I've been through a full deal cycle.

    5Reply
  • Roni E.Pro Member
    Specialist · Earth 2.0 · Member since 2019 · 598 posts · 271 votes
    6y

    The best way to look at it you pushing taxes until the point you have to sell. One unique thing to look at and if the new deal works for is do 1031 with the sponsor. So this way your funds can roll into the next deal with having to pay taxes at that time. So think about like this that snowball is going down the hill and with a good market and sponsor continue to get bigger and bigger. 1031 is a tax deferral at some point you would need to pay taxes. 

    2Reply
  • Taylor L.
    Rental Property Investor · RVA · Member since 2016 · 5k+ posts · 4k+ votes
    6y
    Originally posted by @Nick B.:

    Depreciation is passed to the LP according to their %% of the ownership. E.g. if you own 1% of equity you get 1% of the depreciation of a given year. It reduces taxable income from the property and if that income becomes negative, it is subtracted from other passive income (other property that may have positive income) or ordinary income (if you make less than $100K or you are a real estate professional) or is carried over to the next year.

    Once the property is sold, all previous depreciation becomes a subject to recapture - it is added to the income and taxed at a special rate (20% or so - ask your CPA). Capital gains are taxed after the sale at the long term capital gain rate. However, if you have excess depreciation from other properties that excess depreciation is applied to the capital gains making them tax deferred.

    Ultimately, your taxes (long term capital gains + recapture depreciation) are due in full when all your properties are sold.

    However, if you keep reinvesting you can effectively defer taxes forever similar to 1031.


    DISCLAIMER: I am not a CPA and this in not a tax advice. I am an LP investor though and I've been through a full deal cycle.

     Much like Nick said - many investors keep rolling into properties that have large Year 1 depreciation to apply against their capital gains on sold properties.

    @Yonah Weiss is the main man on using component depreciation (cost segregation) 

    3Reply
  • Spencer Gray
    Syndication Expert and Investor · Indianapolis, IN · Member since 2016 · 591 posts · 808 votes
    6y

    @Nick B. and @Taylor L. pretty much summed it up.

    You can further defer or shelter capital gains by:

    • Never sell the property 
    • 1031 or “like-kind” exchange into another property
    • Additional paper losses from other real estate assets
    • Passing the assets down to ones heirs giving them a stepped up basis
    • Refinance the asset before sale to reduce realized gain

    Check out my write up on the benefits of investing in commercial real estate that is specifically focused on investing in syndications. 

    4Reply
  • Charlotte Dunford
    Investor · Johns Creek, GA · Member since 2017 · 463 posts · 488 votes
    6y

    @Scott Blackwill A side note. Not only does multi-family has depreciation, but also mobile home parks. MHP's depreciate over a shorter time period too so you get more each year. 

    2Reply
  • Natalie KolodijBusiness Member
    Moderator
    Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
    6y
    Originally posted by @Spencer Gray:

    @Nick B. and @Taylor L. pretty much summed it up.

    You can further defer or shelter capital gains by:

    • Never sell the property 
    • 1031 or “like-kind” exchange into another property
    • Additional paper losses from other real estate assets
    • Passing the assets down to ones heirs giving them a stepped up basis
    • Refinance the asset before sale to reduce realized gain

    Check out my write up on the benefits of investing in commercial real estate that is specifically focused on investing in syndications. 

    A refinance won't reduce a gain- it will just reduce cash received at closing. 

    Debt doesn't increase basis. 

    Podcast Guest on Show Pay Less Tax to the IRS This Year With THESE Real Estate Tax Strategies
    Kolodij Tax & Consulting
    WebsiteView Page
    3Reply
  • Spencer Gray
    Syndication Expert and Investor · Indianapolis, IN · Member since 2016 · 591 posts · 808 votes
    6y

    @nataliekolodji

    You're right on not increasing basis. But you shift the bulk of your cash into the non-taxable event of a refi away from the taxable event of proceeds from a sale. Correct or no?

    I've never done this but know owners who have. 

    0Reply
  • Natalie KolodijBusiness Member
    Moderator
    Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
    6y
    Originally posted by @Spencer Gray:

    @nataliekolodji

    You're right on not increasing basis. But you shift the bulk of your cash into the non-taxable event of a refi away from the taxable event of proceeds from a sale. Correct or no?

    I've never done this but know owners who have. 

    No- Gain calculations are based on basis only. 

    All you did was get cash BEFORE closing instead of AT closing. 

    The taxable gain = exactly the same. 

    Podcast Guest on Show Pay Less Tax to the IRS This Year With THESE Real Estate Tax Strategies
    Kolodij Tax & Consulting
    WebsiteView Page
    4Reply
  • Natalie KolodijBusiness Member
    Moderator
    Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
    6y

    You started w/ building basis of $200k

    Depreciated $50k over the years

    Adjusted basis = $150k. 

    You sell for $500k. 

    Gain = $500k-150k = $350k (ignoring closing costs ect for simplification)

    If you owed $100k at time of sale- you walked away with $250k cash. 

    Had you refinanced it a year earlier and taken out $200k. You would walk away with $50k cash at closing. 

    Gain is still $350k. 

    Podcast Guest on Show Pay Less Tax to the IRS This Year With THESE Real Estate Tax Strategies
    Kolodij Tax & Consulting
    WebsiteView Page
    2Reply
  • Spencer Gray
    Syndication Expert and Investor · Indianapolis, IN · Member since 2016 · 591 posts · 808 votes
    6y

    @nataliekolodji

    Would the capital gain liability be on the entire $250k or only the $50k?

    Thanks for the explanation! 

    0Reply
  • Natalie KolodijBusiness Member
    Moderator
    Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
    6y
    Originally posted by @Spencer Gray:

    @nataliekolodji

    Would the capital gain liability be on the entire $250k or only the $50k?

    Thanks for the explanation! 

    Neither

    The gain is the entire $350k. 

    Again it's based on sale price less adjusted basis- the amount of cash you get, or don't get doesn't change a thing. 

    Podcast Guest on Show Pay Less Tax to the IRS This Year With THESE Real Estate Tax Strategies
    Kolodij Tax & Consulting
    WebsiteView Page
    3Reply
  • Bill S.
    Specialist · Raleigh, NC · Member since 2018 · 28 posts · 21 votes
    6y

    @Spencer Gray I have to disagree with Natalie on the $350 Gain. While I am not a CPA, here's how I understand that the calculations @Scott Blackwill and you are requesting will work.

    • $200K acquisition, sold for $500K: Capital Gains tax rate on the $300K Capital Gain taxed at capital gains rate
    • $200K acquisition, current basis at $150K due to depreciation: $50K Recapture taxed at your ordinary income rate

    Maybe Natalie was answering something else - as there is a taxable event on the entire $350K, it's just how it will be taxed that is important to understand. Again, consult your tax professional.

    1Reply
  • Steven Hamilton IIPro Member
    Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
    6y
    Originally posted by @Spencer Gray:

    @Nick B. and @Taylor L. pretty much summed it up.

    You can further defer or shelter capital gains by:

    • Never sell the property 
    • 1031 or “like-kind” exchange into another property
    • Additional paper losses from other real estate assets
    • Passing the assets down to ones heirs giving them a stepped up basis
    • Refinance the asset before sale to reduce realized gain

    Check out my write up on the benefits of investing in commercial real estate that is specifically focused on investing in syndications. 

    Spencer,

    A refinance will do nothing to change the basis or adjust the gains.

    Passing it down to your errors requires a person well, to you know, drop dead.

    Please do not give tax advice that you are not qualified to give all that does is make every accountant here have to work that much harder because of incorrect information like that. There is no way I'd refer a client after that comment and that write up.

    [email protected]224-381-2660
    3Reply
  • Steven Hamilton IIPro Member
    Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
    6y
    Originally posted by @Bill S.:

    @Spencer Gray I have to disagree with Natalie on the $350 Gain. While I am not a CPA, here's how I understand that the calculations @Scott Blackwill and you are requesting will work.

    • $200K acquisition, sold for $500K: Capital Gains tax rate on the $300K Capital Gain taxed at capital gains rate
    • $200K acquisition, current basis at $150K due to depreciation: $50K Recapture taxed at your ordinary income rate

    Maybe Natalie was answering something else - as there is a taxable event on the entire $350K, it's just how it will be taxed that is important to understand. Again, consult your tax professional.

    Natalie is correct and that the gain is $350k. 50k of that may be capped at 25%

    [email protected]224-381-2660
    1Reply
  • Spencer Gray
    Syndication Expert and Investor · Indianapolis, IN · Member since 2016 · 591 posts · 808 votes
    6y

    @Steven Hamilton II Just to be clear I never mentioned a refinance would adjust the basis. This is a strategy that I have seen used by others so I thought I would mention it - happy to to admit when I'm wrong and to have learned something new. 

    0Reply
  • Scott Blackwill
    OP
    Investor · Windsor, CO · Member since 2019 · 21 posts · 18 votes
    6y

    Thank you everyone. That really helped and now I get it Capital gains will always be subject to taxation but deferment is the magic or additional depreciation from other investment properties or syndications. Thank you so much!

    0Reply
  • Yonah WeissPro Member
    Cost Segregation Expert and Investor · Lakewood, NJ · Member since 2017 · 1k+ posts · 1k+ votes
    6y

    Thanks for the shout-out @Taylor L.! Looks like others have already answered here.

    1Reply
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