SD Roth IRA Investing In Syndication - Transfer Depreciation?

Question

I'm just looking forward to the future when I may wish to invest in a syndication through a Roth IRA.

Correct me if I'm wrong but since the Roth IRA has no tax liability, the depreciation deduction is basically lost.

I'm curious, is there a way in a syndication to shift that depreciation that is of no use to me to another partner who can take advantage of it? If so, is there a way to get some compensation for giving them this depreciation?

Michael Plaks · Answer

@Kevin Sobilo

Depreciation is not something separate that "disappears." It is baked into the overall loss passed from the syndication to investors in the initial years. In the last year of syndication, when the property is sold, the entire depreciation from past years is reversed ("recaptured"). The end result when it comes to depreciation is a wash. After the dust has settled, you did not benefit from depreciation and did not suffer from depreciation recapture.

The above effect exists whether you invest inside or outside a retirement account, same exact mechanics. In other words, you should not worry about "redirecting" your depreciation to someone else. It is possible in theory, as Account Closed explained, but is very complicated and thus expensive to implement. And is also pointless, because if you redirect depreciation to another investor, they should redirect the eventual depreciation recapture back to you.

The point of investing in syndications via retirement accounts is not depreciation or, more accurately, early losses. It is shielding from taxes the eventual capital gain from disposition. Which you will accomplish without any tap dancing.

If you want to understand taxation of syndications in general, meaning outside the SDIRA accounts, read this:https://www.biggerpockets.com/forums/51/topics/839015-are-sy...

Account Closed · Answer

Hey Kevin,

You're correct that in a Roth IRA, the tax advantages of depreciation, such as offsetting taxable income, are effectively lost since the account itself is tax-free. Depreciation is valuable to investors with taxable income, but in a Roth IRA, any income or gains are already shielded from taxes, so the benefit of depreciation deductions isn't needed.

As for shifting depreciation to another partner in a syndication, the IRS generally does not allow the reallocation of depreciation solely based on which partner can better utilize it. Depreciation is typically allocated according to the ownership percentages outlined in the partnership or syndication agreement, which are set in advance and follow certain rules under the tax code.

However, some syndication structures can be designed with different classes of partners or special allocations, but these arrangements are subject to complex tax rules, such as the "substantial economic effect" rule under Section 704(b) of the Internal Revenue Code. It's essential that any such allocations are supported by actual economic arrangements, not just for tax purposes.

As for compensation, it’s theoretically possible to negotiate a different economic arrangement within a syndication if another investor finds the depreciation valuable and you don't need it due to the tax-exempt status of your Roth IRA. However, structuring this in a way that complies with tax law would likely require expert legal and tax guidance, as it involves partnership agreements and IRS regulations.

Chris Seveney · Answer

@Kevin Sobilo

Honestly not a fan of investing my tax deferred amounts in syndications that have leverage and depreciation

Rather use my liquid cash for those types of investments to take advantage of the tax code and use my deferred accounts for types of investments that do not have preferential tax treatment (like private lending etc)

John Bowens · Answer

Great question. When using a Roth IRA, your Roth IRA is a tax-exempt entity, therefore, any depreciation deductions that pass through the LLC, can't be used on your personal tax return. In other words, the IRS will not allow you to take advantage of double tax benefits.

Now, you should be aware that when your Roth IRA invests in a real estate syndication, although the Roth IRA grows tax-free, there is a special tax called Unrelated Business Income Tax (UBIT). In the context of debt financed real estate investments, you will also hear this referred to as Unrelated Debt Financed Income Tax. Example, lets say your Roth IRA purchases a property for 100k, with a 50k down payment from the Roth IRA and a loan for 50k. Your debt % is 50%, therefore, 50% of the net income (income after expenses, including depreciation), would be subject to UBIT. Now, you should not fear this, but rather just understand it. In some cases, folks recognize losses that they can carry forward to offset future gains. Now, in the case of investing in a real estate syndication, your Roth IRA will be a Limited Partner (LP) in the LLC structure. Most likely the real estate will have debt, therefore, the income that passes through, NET of expenses and depreciation will be subject to UBIT. Eventually when the property sells, you will have long-term UBIT, which is about 20%, and remember the carry forward loss capability. You will file a 990-T and there are plenty of services out there to help with this.

Hope this response helps!

Chris Seveney · Answer

Oh I am not against it - sorry if it came off that way, was I was referring to more was if I had both cash and a SDIRA, so if I had $50k in each I would put my cash first in a syndication before a SDIRA.

Ashish Acharya · Answer

@Kevin Sobilo You're correct that depreciation in a Roth IRA is essentially lost, as the IRA is tax-exempt. Depreciation can't be transferred to another partner, as it is tied to ownership. Some syndications may offer special allocations, but these are complex and rare. To maximize tax benefits, consider making investments that benefit from depreciation outside the Roth IRA.

This post does not create a CPA-Client relationship. The information contained in this post is not to be relied upon. Readers should seek professional advice.

Kevin Sobilo · Answer

@Chris Seveney, that is a consideration as well along with perhaps note investing.

I still think syndication investing is fine within a self directed Roth IRA (or traditional IRA).

The hold time on a syndication may only average about 5 years, which means when investing outside a syndication you are usually recapturing that depreciation anyways at a time you cannot choose/control as a limited partner. I understand it is possible to 1031 from a syndication but that it can require cooperation from the other partners which in many cases won't happen.

So, if you are paying the tax on that every 5 years whether you want to or not, it is not nearly the same advantage as one's own direct investments where they can 1031 exchange over and over until death and NEVER recapture that depreciation.

John Bowens · Answer

I will add that investing in a real estate syndication where you have Unrelated Business Income Tax (UBIT), if you are going to use a self-directed IRA, you might be better off using a Roth IRA, instead of Traditional IRA, due to the tax-free compounding growth of Roth. In some cases, you will find UBIT is wiped out by depreciation, you may even show net losses on the K-1, which can be carried forward to offset future gains. Then when property sells, you are subject to long-term capital gains, which is generally lower than the standard UBIT tax rates under the estate and trust tax schedule.

Kevin Sobilo · Answer

@John Bowens, that is VERY helpful! Thank you.

I was aware of UBIT and it applying with the use of debt, but I wasn't thinking about it with regard to the depreciation question.

This helped a lot! Thank you!

SD Roth IRA Investing In Syndication - Transfer Depreciation?

SD Roth IRA Investing In Syndication - Transfer Depreciation?

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