MF syndication tax benefit and stratergy

[Daniel Han]

Just trying to make sure I understand correctly the benefit and tax consequences of multi-family syndication investments.

Let's say you invest in a hypothetical syndication deal as a LP, ~20% IRR (2.5x multiple), 7% Preferred Return, Cash flowing from year 1, and exit in 5 years.

and let's assume the sponsor executes perfectly to the plan. and you invest $100k in the deal. The number is made up to make the calculation easier in my head.

Also, assume the first-year tax loss due to depreciation (cost segregation, bonus, accelerated) is 50% of the investment.

In the case above, you have roughly

1. $7k per year preferred return distribution times 5 years = $35k

2. $50k K1 loss

3. no tax on distribution during the entire 5 years because of $50k loss.

4. at the time of sales, you still have $20k loss left

5. at the sales (~2.5 times multiple), you get ~$200k back ($100k original capital + ~$100k profit).

6. you owe IRS capital gain for $80k + recapture of depreciation, depending on your income, up to 20%.

If you don't do anything, then you pay IRS long-term capital gains tax and it's all done.

However, if you invest all the proceed of $200k in the same calendar year on a deal with the same terms, then you generate $100k paper loss effectively offsetting capital gains tax from the first deal.

It seems like you will eventually run out of paper loss unless you put additional money in. however, you can defer the tax quite a bit.

You can continue to do this until you die.... when you go, your kids will get this tax-deferred investment on a stepped-up basis wiping out the tax liability.

Am I understanding it correctly?  What am I missing?

[Brian Burke]

@Daniel Han, the profit from sale is capital gain. I think where your thesis goes off the rails here is using the presumption that you can offset your gain from the first sale from the bonus and accelerated depreciation from the second deal. This really only works if there wasn’t any bonus depreciation taken initially in the first deal.

Let’s say there wasn’t any taken, and you have to recapture $50K in depreciation on the first sale. Then you re-invest, and the second deal takes bonus and accelerated depreciation totaling $150K. That would offset the $50K recapture and the $100K gain.

But if the first deal used bonus and accelerated depreciation, when you sell you might have $100K of depreciation to recapture (your entire initial basis). Now when you reinvest you still get the $150K bonus depreciation but you have to recapture $100K from the first deal, leaving you with $200K taxable and $150K to offset it—resulting in tax on $50K of gain. 

At least that’s my non-accountant, non tax-advisor, layperson’s observation of how it works, and of course these numbers are for illustration purposes only.

If syndicators are telling you that you can eliminate your tax liability by reinvesting, they should stop telling you that. Mitigate, yes, eliminate, no.