Taxes in Syndications
Syndications
It’s the larger deals $1M loan size and larger Fannie/Freddie deals that are getting all the Government bailouts of forbearance. Not the mom and pop landlord. See the forbearance guidelines for the big players at the bottom of this page.
Mom & Pop Investing
The mom and pop investors did not get much government support and from what I remember from others in our free Facebook group suffered in terms of collections (collecting rent from tenants).
Those of you who own rentals on your own should remember how exposed the mom and pop landlord was with their one-off rental property as you pestered your overwhelmed property manager who was also managing 100-300 other clients.
Those with rentals in Blue states… remember how you could not evict your entitled tenants who have the money but chose to play the courts for 12 months. Absolutely crazy!
But what about taxes?
One of the most common questions I have been getting over the past couple of weeks is how are the tax benefits transferred to the LP or passive investors on a syndication deal?
As a passive real estate investor (who is greater than $500,000 net worth or making over $150,000), it’s essential to understand the tax implications and benefits of investing in a private investment fund/syndication/private placement.
These investments are typically organized as partnerships in the form of LPs (limited partnerships) or LLCs (limited liability companies).
The investment fund invests the money it pools from investors, and each investor shares in the profits and losses in proportion to the investor’s interest in the investment company. Investors are treated as passive partners for tax purposes.
Most investment funds prefer the partnership tax structure over the corporate structure to avoid double taxation and to allow for the fund’s income to be taxed at the investor level and provide for the flow-through treatment of income, expenses, gains, and losses.
Each investor receives a K-1 tax form at the end of the year, reporting the investor’s allocated share of these income, expense, gains, and losses items for inclusion in their tax returns. As a general rule, an investment fund’s profits and losses are allocated to investors on a pro-rata basis unless there are special allocations of income, expenses, gains, losses, etc. as agreed upon in the partnership agreement.
Also as a general rule, profit distributions (including preferred returns) from income that is connected with the fund’s trade or business are taxed as ordinary income. However, this regular income can be offset by the partner’s allocated share of deductions and depreciation.
Also, thanks to the 2017 tax reform, taxpayers who earn less than $157,500, or $315,000 for a married couple, can deduct 20% of the income they receive via pass-through businesses from their overall taxable income.
If a partner receives a distribution from the partnership that is above the partner’s share of the fund’s income as reported on the K-1, these distributions will be considered a return of capital.
While any distributions considered a return of capital is not taxable, the distribution lowers the basis (i.e., original cost) of the partnership interest, which will affect the number of capital gains realized when the interest is sold or liquidated.
Capital Gains or Distributions from the sale or liquidation of a partnership interest will be treated as capital gains – short-term or long-term, depending on the holding period. The number of recognizable capital gains will be directly impacted by the partner’s basis in the partnership interest (i.e., outside basis, capital account balance).
Tax Basis (Capital Account) – A partner’s original basis in his/her partnership interest begins with the original capital contribution, and then over time, taxable income and additional contributions will increase the basis.
At the same time, depreciation, expenses, and distributions will reduce it. The basis is further enhanced by the partner’s share of partnership liabilities and reduced by repayments of liabilities.
K1 Tracker Form: You might not be in 1,000+ units yet or a dozen deals but here is a great way to keep track of it so you can be ready for the exciting tax mitigation strategy with your CPA
Syndication Investment Example:
An investor makes an initial capital contribution of $1,000,000 in exchange for a partnership interest; his initial tax basis will be $1,000,000.
The fund has generated $400,000 in annual revenue, $200,000 in operating expenses, and has allocated $100,000 in depreciation over the life of the investment.
Total taxable income amounted to $100,000 ($400,000 – $200,000 – $100,000). The investor’s share of income that income is $50,000 distribution payments totaled $100,000.
The partner’s ending basis in the partnership will equal $950,000 as outlined below:
If the investor receives $1,000,000 for his partnership interest from a sale or liquidation, that will result in capital gains of $50,000 ($1,000,000 – $950,000).
If you’re considering investing in a private fund, we recommend you consult your tax advisor for a complete discussion of the tax factors of passive investments.
