Tax question re: passive investor in a real estate syndication

Tax, SDIRAs & Cost Segregation
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Tax question re: passive investor in a real estate syndication

Jay Amin
Member since 2020 · 8 posts · 4 votes

I'm very new to real estate investing, but have a few questions about the tax benefits of becoming a passive investor in a real estate syndication investing in multifamily residential properties.  According to section 469 of the tax code (I'm not a CPA), the losses from passive investing can be used to offset the gains from passive investing.  Does that imply the monthly distributions received from these properties are essentially exempt from federal income tax?  Also, the losses exceeding the gains can be carried forward to the following year and be used to further offset future gains?  What happens when the properties are sold?  There is a capital gains tax (20%), but there is also another tax  "depreciation recapture".  I am assuming that the losses being carried forward from year to year, can be used to offset those as well once the properties are sold?  Also, I have no intention of becoming a "real estate professional"

Thanks!

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AJ ShepardPro Member
Real Estate Syndicator · Portland, OR · Member since 2014 · 453 posts · 312 votes
6y

@Basit Siddiqi is right. A lot of time syndications will return capital first then disperse gains. The idea is that paying taxes today is more expensive than paying taxes tomorrow.

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  • Christopher Smith
    Investor · brentwood, CA · Member since 2016 · 1k+ posts · 730 votes
    6y

    Distributions will reduce your tax basis to the extent thereof,

    Suspended losses carryforward,

    Any suspended losses remaining at sale are released.

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  • David M.
    Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
    6y

    @Jay Amin

    There are different “categories” of income for income tax purposes, and they are “bucketed” together in your tax return and treated differently. Ordinary income is your wage or salary.... passive income is the income from rentals. Capital gains is the sale of stocks, bonds, and real estate property.

    So, as I said rentals are passive income. Current rules generally limit the amount of passive losses that you can bring onto your main 1040 to reduce your overall taxable income. You don’t “lose” those losses/deductions. They just carried over to the following year where maybe you can offset them with some gains (ie passive income gains). Same thing happens with stocks for capital gains.

    Part of determining your profit/loss is a non-cash deduction called depreciation. This actually is applicable to just about any business. In the case of passive real estate investment, you should be taking depreciation deductions on the improvements to the property, ie the house, and not the land value. This helps reduce your taxes year after year. However, there is no free lunch with the irs. When you go to sell, there is depreciation recapture, applicable to all businesses. This recapture is taxed as ordinary income. However, for real estate there is an exception. There is no depreciation recapture. But there is no free lunch... instead, the depreciation unrecaptured is taxed at about your capital gains tax rate (this part of the tax calcs gets confusing to me.. it’s just not the higher ordinary income rate) . It even can be offset with capital lossses since it goes through SchD. The point is the sum amount of depreciation you had to take year after year is subject to tax up to your sales price or cost basis. Above your cost basis, that amount is subject to capital gains tax.

    When you sell your interest in the property, as alluded to above, everything comes “flooding” onto your tax return. Any saved up passive allowed losses can be taken on your 1040. The depreciation unrecapure tax flows through the SchD. Finally, the capitals gains tax on any appreciation is also calculated in SchD.

    Of course, talk to a professional about your situation. That’s just a very quick, two cent summary hope it helps. Good luck

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  • Basit SiddiqiBusiness Member
    Accountant · New York, NY · Member since 2015 · 8k+ posts · 3k+ votes
    6y

    @Jay Amin

    There are a couple items wrong in your post

    Capital gains tax is not necessarily 20%
    It can be 0%, 15% 20%
    There is a potential that your capital gains tax will also be subject to Net Investment Income Tax(3.8%)

    Distributions from a syndication are considered...distributions. They are not necessarily income. They can just be a return of capital.

    [email protected]917-280-8544
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  • AJ ShepardPro Member
    Real Estate Syndicator · Portland, OR · Member since 2014 · 453 posts · 312 votes
    6y

    @Basit Siddiqi is right. A lot of time syndications will return capital first then disperse gains. The idea is that paying taxes today is more expensive than paying taxes tomorrow.

    1Reply
  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    6y

    @Jay Amin

    Read this thread:
    https://www.biggerpockets.com/forums/51/topics/839015-are-syndications-extremely-tax-efficient

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  • Jay Amin
    OP
    Member since 2020 · 8 posts · 4 votes
    6y

    Thanks very much to all those that have commented!!  I really do appreciate it.  

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