Tax questions on Syndication exit

[Peter Lampione]

Thanks for all the great info on this forum.  I found a few posts similar to what I'm looking for but couldn't find the exact answer so creating this post, apologies if it is fully answered somewhere.

Trying to understand the specific treatment of suspended losses against syndication capital gains and depreciation recapture.  As an example:

- Invest in Syndication 1 in Year 1 for $100,000, realize $60,000 depreciation

- Invest in Syndication 2 in Year 2 for $100,000, realize $50,000 depreciation

There are typically distributions that would use up some of the depreciation losses, but ignoring them here for simplicity (I have many deals that have created a lot of losses).

- Syndication 1 exits in Year 3 for $150,000.  There is a gain of $50,000 and depreciation recapture of $60,000.

From year 1 and 2 there is a total of $110,000 is suspended losses.  Would that $110, be able to offset the $50,000 gain (taxed at cap gain rates), and the $60,000 taxed at 25% recapture rate?

I have read many places where people mention the losses need to be generated in the same year as the sale in order to offset the sell, but in other cases they imply that prior year losses can offset both gains and recapture?

Thanks,

Peter

[Duke Giordano]

For simplicity, and this is not tax advice.  It is my understanding that passive losses/depreciation from "any year" can be carried forward (On I believe form 8582) to then offset passive income whether it be capitol gains OR depreciation recapture.  Therefor, does not have to be in same year.

[Peter Lampione]

Quote from @Duke Giordano:

For simplicity, and this is not tax advice.  It is my understanding that passive losses/depreciation from "any year" can be carried forward (On I believe form 8582) to then offset passive income whether it be capitol gains OR depreciation recapture.  Therefor, does not have to be in same year.

 Thanks Duke, appreciate the response. That was my understanding, definitely conflicting info out there. 

I have a handful of deals that exited last year from the same sponsor. I’m surprised to see most of the gain is showing in box 9a on the K-1, is that typical or is the gain usually in box 10 and the recaptured depreciation in box 9c?

[Paul Camuto]

Accountant anyone?

[Ashish Acharya]

It doesn't have to be the same year to offset.

I would expect box 10 to have some balance but there are other factors involved to make that determination. Box 10 and 9a are taxed the same but separations are important at other levels. 

[Peter Lampione]

Thanks @Ashish Acharya, I thought if it was in box 9a I wouldn't be able to offset it with suspended passive losses, good to hear I still can.  I'm going to dig into the details with my accountant to make sure I fully understand it and we got it right (my accountant is not an expert on this but seems to work it out).  Wanted to get some other opinions before I started digging in.

[Peter Lampione]

@Ashish Acharya, sorry, one follow up question.  The reason I started this thread is that people tell me, and I read that passive losses can't offset gains and recaptured depreciation, unless the following conditions are met:

1. Disposition of an entire interest (or substantially all)

2. In a fully taxable event (where all gain/loss is realized and recognized).

3. To an unrelated party.

I assume that the sale of one syndication deal meets the requirements of #1 and allows suspended losses from all syndication deals to be used?  Just trying to understand the logic behind how this is allowed.

Thanks again,

Peter

[Greg O'Brien]

@Peter Lampione passive losses can offset gains from passive activity dispositions. Have your accountant prepare a mock 8582 and watch how it all flows! This is widely misunderstood IMO

[Lane Kawaoka]

All investors will have to pay back the depreciation recapture (losses taken throughout the hold) and capital gain (the big payout on the end which is sale minus cost basis). But don't despair because although this is the case when you look at it myopically, in reality most investors go into multiple deals accumulating 100s of thousands of passive activity losses in their first few years investing. Those losses do not go away, but they become suspended to be used to offset future passive income and sales/capital events like this in the future. When you exit a deal, what normally ends up happening (like Tom Brady keep winning more Super Bowls) is that you go into two more deals (with now double the amount of capital) and you will likely find that with those new K1s you could result in you having way more passive losses you began with If you can see where this is going... yes, experienced investors with a lot of capital deployed might have 500k-1M+ suspended passive losses and have not paid taxes in years and do not appear to pay taxes for years! (you can find how much suspended passive losses you currently have on your IRS Form 8582 - which your CPA is likely not giving to you and in that case you should get a new one)

Another example: Assume you invest $100,000 in a syndication and the cost segregation yields $20,000 of depreciation. You hold the asset for five years and it is sold for $150,000. You have $50,000 of capital gain and $20,000 of depreciation recapture. Assuming your capital gains tax rate is 20% and you made no further investment, you would owe tax of $10,000 on the gain and $5,000 on the recapture.
Now assume you took the $150,000 and invested it in a new syndication and got the same 20% cost seg, so $30,000 of depreciation. The new depreciation would first offset the $20,000 of recapture then the remaining $10,000 would offset some of the capital gain from the previous sale leaving you with $40,000 of gain. You would pay 20% tax on the $40,000 and the tax owed would be $8,000 rather than the original $15,000. If you have other passive loss that you have been carrying from other investments, that could be used to further defer and reduce the tax.

[Peter Lampione]

Thanks again everyone for the really helpful responses.  I'm going through my draft return from my accountant for 2021 to try and understand the numbers more specifically and this info is very helpful.  And I do see that my accountant included a list of all carryover losses for next year with the 'disallowing form'.  Many say 8582, some say 8582AMT, and a few are 1116 or 1116AMT (looks like they are related to foreign sources), NJ-BUS-2 (NJ forms), and there is one line item for 8995.  I'll dig into all of thus, thanks again for your help.

[Peter Lampione]

Thanks again @Lane Kawaoka, @Greg O'Brien, @Ashish Acharya.  I went through my draft return for 2021 (well over 100 pages).  My accountant did include form 8582 and other relevant forms.  I was able to determine that box 10 gains were included, but box 9a gains were not.  Form 8582 Part I, line 2a (from Part V) is not including the 9a amounts as net income, so as a result that amount is not being included in determining the amount of losses allowed to apply.  I've read in some other threads that 9a cannot be offset by other passive losses as it is not considered passive.  That would be unfortunate as the 9a amounts are very large.  Just double checking with this group in case you think there is anything else I might be missing?

Thanks again,

Peter

[Paul Moore]

Hi @Peter Lampione. You got some wonderful responses above! This forum post reminded me why it is important to have a great real estate-oriented CPA and tax strategist. I know someone who had a CPA who didn’t follow some of the stuff you guys are saying above and it cost his client over $100,000 annually. When my investor friend got a great tax strategist his tax bill went to almost $0 and he has been able to continually generate great cash flow and returns legally using the tax code that was designed to help us as investors. Happy investing!

[Peter Lampione]

Thanks @Paul Moore, definitely agree on that. It looks like what my accountant is doing is correct, I was just surprised because multiple people have said you can offset all gains with losses, included gains in box 9a. I even tried it on some tax software myself and confirmed it. Unfortunate that my syndication sponsor captured most of the gains as long term gains (box 9a). So in some cases you can offset all gains, but it would appear not in all cases. 

[Basit Siddiqi]

just because you did it in a 'software' doesn't mean that you 'confirmed it'.

The tax software helps with the tax process, it doesn't replace it.

If you enter information incorrectly or don't check a box, the output of the tax software is garbage.

Your accountant is likely not doing it correct - best of luck.