What Passive Investors Need To Know About Taxes

Many investors gravitate toward real estate syndications after several unpredictable cycles in the stock market and realize there’s a grand opportunity to earn returns without being landlords. The transition from stocks to commercial real estate investments is accompanied by the surprising benefit of paying fewer to no taxes.

You may have heard that real estate investors don’t pay any taxes but are not sure how that really works in reality.

Plus you might be an upstanding citizen and are not interested in breaking the law.

Fear not — let's break down how investing in real syndications can enable you to legally not pay taxes.

1. Depreciation Expense

This is perhaps one of the only times that expenses are your best friend.

Most real estate syndications will conduct a cost segregation study on the property ie. apartment building. This will enable us to accelerate depreciation expense on the property from 27 1/2 years to 3 to 5 years for specific parts of the building such as cabinets, carpeting, and lighting.

Therefore in potentially years 1 through 3 investors will receive K1s with negative balances. These negative K1s enable them not to pay taxes on any of the operating distributions they received during the year. Sounds like a great deal?

2. Passive Losses

Now you are thinking — I am going to have to pay taxes when the property sells. The answer is potentially but there are ways around it. First, it is important to talk to your CPA about your personal financial situation. I am not giving individual tax advice in this article.

Secondly, you might be concerned about depreciation recapture at sale and that any changes in the 1031 exchange rules will wipe out your ability to defer taxes on real estate. This brings me to the concept of passive losses.

Chances are you probably could not take all the passive losses in the earlier years of the investment hold period. These passive losses that can be deferred indefinitely can only offset passive income and hence investors can use them at the point of sale to offset some of their gains.

3. Investing

If you still have gains from the sale of the real estate syndication investment, you can consider investing in another real estate syndication in the current year. You want to ensure that the new investment plans also do a cost segregation study on the property so that you will have passive losses to offset your passive gains.

You can also consider investing in passive start-up businesses as well. Many start-up businesses experience losses in their early years that passive investors of the business can use to offset passive gains from other investments.

Lastly, some investors might choose to invest passively in real estate investments in an expensive market like Los Angeles and be okay with losses for future appreciation. As they can use those passive losses during the hold period to offset gains from other passive investments.

Remember the beauty of passive losses is that they can be deferred indefinitely!

Key Take-Aways

Investing in real estate syndications can not only enable you to generate passive income and build wealth it can also enable you to invest tax-efficiently. Many investors do not consider the tax impact of their investments, especially in stocks and cryptocurrencies which have no tax benefits despite their ability to generate volatile returns. Hence, it is prudent to consider adding real estate investments to your portfolio to assist with growing your wealth for the long term and keep your tax liabilities at bay.

About the Author

Lisa is the CEO of Lisahylton.com, a real estate company that helps entrepreneurs invest in tax-efficient real estate investments. At Lisahylton.com, Lisa and her team focus on buying apartments with investors and shares the profits. This strategy enables her investors to build wealth and passive income through investing in conservative, high-quality multifamily assets.

Lisa is the host of the Level Up REI podcast where she interviews real estate investors, entrepreneurs, and business owners to share their stories and experiences building businesses and investing in real estate. After a decade of working in the financial services industry, Lisa found investing passively in real estate syndications and was intrigued by the business opportunity to invest in real estate while also providing the opportunity to others to do the same along with her.

You can learn more about passively investing in high-quality multifamily assets that provide cash flow and strong returns at www.LisaHylton.com.