What Are The Tax Benefits When Investing in An Apartment Syndication?

If you want to produce passive income from investing, one of the most important considerations you need to make is how much of it you have to provide to the government in the form of taxes. The taxes that you pay might vary quite a bit from one asset class to the next, with multifamily real estate coming out on top as the undisputed victor. So, from a financial point of view, what are the advantages of investing in apartment buildings? And exactly how much extra money will you owe the government come April if you decide to invest in the stock market instead of other options? What I'm about to share with you is something that I picked up from Tom Wheelwright, the author of the book "Tax Free Wealth," which, if you haven't already, is an absolute necessity to read.I take you on a tour of the tax rules in the United States and explain how they work to our advantage as real estate investors.After that, I compute the amount of taxable income that would be generated from two comparable investments: the first is in the stock market, and the second is in multifamily housing. If you want to produce passive income from investing, one of the most important considerations you need to make is how much of it you have to provide to the government in the form of taxes. There is a difference in the amount of taxes you have to pay based on the type of asset you own, with multifamily properties coming out on top. So, from a financial point of view, what are the advantages of investing in apartment buildings? And exactly how much extra money will you owe the government come April if you decide to invest in the stock market instead of other options?

INVESTING IN STOCKS

Suppose you invest $1,000,000 in the stock market and earn a return of 10%, or $100,000, on your investment. After paying taxes on your capital gains of $20,000, you will be left with $80,000, which represents an increase of 8%. Not terrible, but $20,000 is a significant sum of money nonetheless.

TAX LAWS FAVOR REAL ESTATE INVESTING

Tax law provides investors in real estate with the ability to operate under a different set of guidelines. The Internal Revenue Service allows us to depreciate the value of a building over a period of 27.5 years, during which time we can write off a portion of the depreciation as an expense and, as a result, our taxable income can be reduced. An even better offer is made to investors in multifamily dwellings: we are permitted to quicken that depreciation and can do so by using a cost segregation study to break down the cost of each component of the property individually. This implies that an engineer will visit the property, examine the many components (ranging from the carpet to the landscaping to the roof), and devise a bespoke depreciation schedule. What's the takeaway here? Over the course of seven years, we are allowed to deduct up to 90 percent of the building's worth. That is really potent material.

PHANTOM LOSS/PAPER LOSS

In order to better understand how these principles should be applied, let's have a look at an example. If you invested $100,000 in a transaction that offered a cash-on-cash return of 10%, you would accumulate earnings of $10,000 for that particular year. But when you get your K-1 statement, it won't show a gain of $10,000 like it did before. Instead, it is more likely to show a loss of roughly $4,600 in this area. Why? Your revenue is decreased due to the accelerated depreciation, which is approximately 3.65 percent of the total value of the property. To make matters even more favorable, the most recent tax reform bill enables us to deduct the full value of a building in the first year (this practice is known as "bonus depreciation") of its existence. Because of this, we have the ability to continue carrying forward our passive losses until the time that we sell the property, at which point we can use those losses to offset any capital gains.

STOCKS VS REAL ESTATE

Going back to the beginning of our illustration, let's say that instead of putting one million dollars into the stock market, you put it into real estate that has many units. We deduct 1.46 million dollars from our taxes by applying a tax credit equal to 3.65 percent of the value connected with the building. You once again earn one hundred thousand dollars with that same cash-on-cash return of 10%. You display a taxable LOSS of $46K even though you made a GAIN of $100K due to the fact that your depreciation was $146K. And because you won't be handing over a portion of your passive income to the federal government, you'll be able to reach your goal of achieving financial independence much more quickly. When the tax law is taken into consideration, there is no investment that is more advantageous than real estate with multiple units for rent.

MORE ON COST SEGREGATION

As mentioned above, cost segregation is the process of identifying personal property assets that are associated with real property assets, and then separating off personal assets for the purposes of tax reporting. This process is required by the tax laws and accounting regulations of the United States. The operation is as follows: The Internal Revenue Service (IRS) permits you to deduct, or "write off," a paper loss from your annual taxable income. In most cases, if you own rental property, you will be able to deduct the total value of the property from your taxable income over a period of 27.5 years. Which is wonderful! You have the money that is generated by the rental property, and you also have the expenses that are associated with it. These expenses include the interest on your mortgage, management fees, and any other expenses that may arise, such as the need to replace a boiler. After deducting these costs from your income, the amount that is left over is the portion of your income that is subject to taxation. But wait – you're not done yet! You can still deduct a loss on your tax return for the amount that the property's depreciation has cost you. This reduces the amount of your income that is subject to taxation. The practice of cost segregation is what makes this one of the most beneficial tax advantages currently available: The depreciation schedule can be sped up by using cost segmentation, which gives you more money. As I stated earlier, if you don't bother with cost segregation, you can write off the value of the apartment building over a period of 27.5 years. You'll be able to speed up that schedule and start taking depreciation payments MUCH sooner if you use cost segregation.

TAX DEFERMENT VS AVOIDANCE

In a sense, depreciation allows one to avoid paying taxes. It is an expense in the eyes of the IRS, and as a result, it lowers the amount of income that is subject to taxation at this time. This results in a tax benefit. To put it another way, you are quite literally avoiding paying taxes. However, you may be required to pay taxes on the gain when you sell the asset. This is the point at which you may make the argument that the appreciation could represent a tax deferral. For instance, if you owe taxes, you must also pay taxes on whatever gains you may have accumulated. You spend one million dollars to acquire some real estate. After a number of years, you eventually decide to sell it for $2 million. You have a gain of one million dollars that is subject to taxation. However, as a result of the depreciation, your base will be reduced. To put this another way, when the Internal Revenue Service computes your gain, they do not use the whole price. Instead, it is one million dollars less the amount by which you depreciate it. Purchase Price – Depreciation = Basis If I depreciate $800,000 from bonus depreciation. My actual basis (my starting point) is $200,000. As far as the IRS is concerned, they're going to tax me on a gain from $200,000 to $2 million. It’s a $1.8 million gain that you’re taxed on, which is called depreciation recapture. You are currently benefiting from the depreciation, but there is a possibility that you will have to pay for it in the future. There are now methods available to put off paying the tax as well. For instance, there is a transaction that is known as a 1031 Exchange. It basically gives you the ability to take the profits you've made and invest them in another piece of real estate that is of equal or greater value.

What Does It Look Like In A Real Life Syndication Deal

Here is an example for your consideration. Let's say you invest $100,000 in an apartment syndication deal, and let's also say that the lead sponsors give you an 8% return on your money. That translates to an 8% return based on cash flow. You are going to put that money in your bank account, you are going to use it to go on vacation, you are going to spend it, or you are going to do whatever else you want to do with it. The next step is filing your taxes. You will receive a document that is referred to as a K1, which is your tax statement. (You should provide your CPA with the K1 so that they can also prepare your taxes.) On the K1, it says that you received a $8,000 payout; however, your taxable loss comes out to be $40,000, which is a complete mystery (or some giant number). Despite the fact that you have a taxable loss, you have made money. And precisely for this reason, individuals were attacking Trump because of that. They believe that he must be a poor investment because he has a taxable loss. This leads them to this conclusion. While everything is going on, he is accumulating millions of dollars in his personal wealth. This is a concept that is beyond the comprehension of the typical individual. The investor in many dwellings can reduce their effective tax rate while also increasing their cash flow. This additional depreciation really shines when viewed in light of that aspect. You have a taxable loss, and you may apply it as a credit against any other tactics for generating passive income that you might be utilizing (investing in other businesses, oil, whatever it may be). In addition, you have the option of carrying any unused depreciation over to the following year by "rolling it forward." So let's imagine that the next year, you receive another $8,000 in income from your investment. You are able to neutralize that advantage by making use of any passive losses that you haven't done so already. Brilliant! Thousand Doors is familiar with a significant number of full-time investors who, in practice, pay very little or no taxes. The government has done a lot of work to make this system favorable to people who invest in real estate.

WE'RE HONORED TO BE IN BUSINESS WITH YOU

Building wealth doesn’t always require you to do all the work you normally would as an independent real estate owner/investor. You can also accomplish the same goal by taking advantage of a syndicated real estate project.

If you're interested in learning more about how syndication works or if you're ready to start investing in one of Thousand Doors Group's current syndication projects, feel free to click the INVEST NOW button on the top of the website or contact us today. We Look Forward To Working With You!