Crowdfunding and taxes

[Andrew Faukner]

Let me know if have this right. If I use a crowdfunding company like Reality Shares, or Groundfloor, and I receive interest in 6 months, it is considered ordinary income for taxes. Or, if I receive the interest after one year, it is considered long term capital gains. Is this correct?

[Ian Ippolito]

No, not really. I'm not an accountant or lawyer, so always consult with your own for financial advice.

First, you're talking about two completely different types of investments. Ground floor is all debt and realtyshares is mostly equity. The exact type of income you will see varies depends not just on the length but also if you are investing in debt or equity, and the structure (an offering structured as a REIT may be different than structured as an LLC). Depending on the circumstances, you may be subject to the state taxes that the investment is in, on top of national. Then on top of that you might have depreciation that offsets it. So you should always check with the sponsor or platform to find out for sure.

For example, on Arixa Capital (a debt fund I'm invested in), it's reported as interest income. But in Broadmark (another debt fund) it's reported as ordinary business income. They are planning to convert to a REIT this year to take advantage of the additional 20% deduction, and I believe this could change it to be reported as something else.

On an equity fund, you may have distributions like the above, and at the end when they sell the property you may have long-term capital gains (or possibly even short-term if they are really flipping it fast).

However, offsetting the distributions above is that equity funds have depreciation benefits (and some more than others). Depending on the asset class, it may shield anywhere from 20% to 100% of the distribution from taxes. What this means is that your investment might show a K-1/tax loss (and thus you owe no taxes on it) even though you received money from it in distributions. This will eventually be recaptured when they sell so it's not a permanent deduction. Unless you/they are doing a 1031 exchange into another investment, in which case it can be deferred also. The 1031 will also let you defer capital gains.

And if you daisychain 1031 exchanges, you can implement the strategy of "defer, defer and die" where you pay none of those taxes and when you die, your heirs inherit on a stepped up basis and don't pay taxes either.