Depreciation Recapture via Syndication in SDIRA?

[William Edwards]

Would there be any considerations regarding depreciation recapture when a syndicated investment is disposed (ex: at 10 years) when purchased via an SDIRA (Self Directed IRA)?

Will those investment funds need to be 1031'd at disposal?

My thought process is that since the investment is held in an IRA, they haven't had a tax benefit from depreciation during the hold period (with the possible exception of reducing UDFI/UBIT liability on the leveraged portion) - so, it would possibly be a mute point.

I'm considering using an SDIRA to invest in a syndication as an LP and trying to think about all the angles.

Thanks in advance.

-William Edwards

[Brian Eastman]

@Oleg Shalumov & @Scott Mac

It is hard to provide an estimate of tax impact on a syndicated deal.  There are just so many variables.  It really is the kind if thing where you need to take a pro-forma of the investment and have your CPA do the analysis.  The plan can pay for that tax review, by the way.

I am travelling to some investor groups this week and therefore do not have access to some of the resources in my office.  We've done some analysis for a syndicate or two in the past, but mostly focused on the UDFI impact on the operating income, but not the endgame.  

I'm working from memory so the numbers are incredibly rough, but the basics are as follows:

$100k limited partner investment into an apartment syndicate using 25% investor capital and 75% debt.  Typical scenario of purchasing an older apartment, upgrading the facilities and management over a period of years, holding for a bit and then selling.  The average 5 year returns were projected at about 15% via cash flow.  The $100K investor would have about a $900 per year tax bill.  A typical erosion of about 1% of the gross return percentage is in the ballpark of what to expect, so taking 15% down to 14% net, as a rough guide.  

The sale is a much more complex matter due to factors such as costs of upgrades, depreciation recapture, time frame, remaining debt balance, etc.  The UDFI tax on the gains may be a not insignificant number like $7-10K, but it will be an overall relatively small amount compared to the total gain received.

While it is certainly important to have your tax professional run the numbers when evaluating a deal, the key is to keep your eye on the net after-tax returns, not necessarily what the tax cost itself is. If the performance of a leveraged deal is better than the performance of a deal without leverage, then the fact there is an internal tax cost in the mix does not really matter.