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  • Tax exit strategy from individual real estate syndications

    What is the best way to minimize taxes in a real estate syndication when you exit the investment? My understanding of the tax situation is this:
    1) You invest an amount, let's say $100,000 into the syndication and most these days are doing a cost segregation study and passing through accelerated depreciation. Let's say that in that year you get a $5,000 distribution and $35,000 of depreciation which includes the accelerated depreciation part (I've been getting 35-45% or so first year).
    2) Years 2-5 get $5,000 distributions sheltered by additional depreciation, let's say $5000 a year to keep things easy. No tax due at this point, and still have $30k of pass through depreciation from year 1.
    3) Property is sold after year 5 for $120k, resulting in a gain of $20k. At this point you have to start thinking about taxes, and depreciation recapture. My understanding is that at the time of sale the prior distributions are taxed at depreciation recapture rates (max 25%) while the gains are taxed at capital gains tax rates. (20% federal for me, plus state tax as I live in CA).

    At this point is the plan to reinvest everything into a new syndication and get the accelerated depreciation to shelter the gains? With the sunset of accelerated depreciation starting after next year (2023) it seems like this strategy will be losing its power over the next 5 years or so as this phases out and we will be left with only straight line depreciation.

    After looking at the post tax implications I think that this may favor the evergreen funds that don't have the tax bomb built in, vs running your own property with the ability to do a 1031 exchange. Seems like a shame since I do believe that there could be a bit of outperformance possible with the individual syndicated property route by picking a few great projects/sponsors who might outperform a broader index.

    Thoughts?

  • #2
    From what I've been able to gather and from WCI recent blog post on the subject (search for it) you seem to be able to use any leftover depreciation losses like from year 1 cost seg to offset any regular (non passive) income during the year of syndication sale. HOW you go about doing this I havent figured out yet....assume it's on some tax form. Guess I'll cross that bridge when I get there.

    Comment


    • #3
      Once you start getting this far into the weeds it seems like a good idea to get hooked up with a knowledgeable CPA. It will likely pay for itself.

      Comment


      • #4
        For this exact reason, we are not investing in syndications. The loss of control over the tax consequences upon sale is too great a downside for us on syndications. Because of this tax issue, we prefer direct real estate investment.

        We are in contract with a single partner on an 83-unit multifamily property near a major tertiary medical center that will rent to nurses and residents, along with other middle income folks living in the community. The goal is to provide high quality, up to date housing at an affordable price point for middle class professionals, very good for the community. At the same time, it should be a good investment for us.

        Returns will be approximately 10% cash on cash, 15% annual equity appreciation (based on 80% LTV with 3% market appreciation), and 10% mortgage principal paydown per year. The pretax IRR is around 35% per year. In year 1 with a cost segregation study, we will get around 45% return from the tax savings on the bonus depreciation. So the first year return, all in with all 4 components is around 80%. Subsequent years the return will be somewhere around half of that.

        Direct real estate investments are high risk, high reward, but if everything works out the returns can be impressive. It took us decades as real estate investors to get to this level. We started small in the early years, and this will be our largest deal to date. This property will hopefully remain in our portfolio until death, when it might pass to our heirs at a stepped up basis. Nevertheless, it may have to be sold to pay the estate taxes.

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        • #5
          Thanks for the responses. I think I’ll hold off on further individual syndication deals for now based on this. Uncontrolled exits even with a 15% IRR may only be 10% or so after CA state tax and depreciation recapture taxes.

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          • #6
            Given the quantity of advertising here by real estate syndicators, I think the question posed by the OP should be receiving much more attention, as it will have a major impact on the final IRR for these types of investments for high income doctors.

            The evergreen funds (DLP, Origin, others?) are certainly a way around this (for now), but with minimum investments of $100k this will be difficult to stomach for many.

            I don't see any opportunities to 1031 exchange into syndications being advertised - are they out there?

            Comment


            • #7
              Originally posted by White.Beard.Doc View Post
              For this exact reason, we are not investing in syndications. The loss of control over the tax consequences upon sale is too great a downside for us on syndications. Because of this tax issue, we prefer direct real estate investment.

              We are in contract with a single partner on an 83-unit multifamily property near a major tertiary medical center that will rent to nurses and residents, along with other middle income folks living in the community. The goal is to provide high quality, up to date housing at an affordable price point for middle class professionals, very good for the community. At the same time, it should be a good investment for us.

              Returns will be approximately 10% cash on cash, 15% annual equity appreciation (based on 80% LTV with 3% market appreciation), and 10% mortgage principal paydown per year. The pretax IRR is around 35% per year. In year 1 with a cost segregation study, we will get around 45% return from the tax savings on the bonus depreciation. So the first year return, all in with all 4 components is around 80%. Subsequent years the return will be somewhere around half of that.

              Direct real estate investments are high risk, high reward, but if everything works out the returns can be impressive. It took us decades as real estate investors to get to this level. We started small in the early years, and this will be our largest deal to date. This property will hopefully remain in our portfolio until death, when it might pass to our heirs at a stepped up basis. Nevertheless, it may have to be sold to pay the estate taxes.
              do you mind sharing any book recommendations that helped you along the way with calculations and learning how to assess a properties investment potential?

              Comment


              • #8
                Originally posted by White.Beard.Doc View Post
                For this exact reason, we are not investing in syndications. The loss of control over the tax consequences upon sale is too great a downside for us on syndications. Because of this tax issue, we prefer direct real estate investment.

                We are in contract with a single partner on an 83-unit multifamily property near a major tertiary medical center that will rent to nurses and residents, along with other middle income folks living in the community. The goal is to provide high quality, up to date housing at an affordable price point for middle class professionals, very good for the community. At the same time, it should be a good investment for us.

                Returns will be approximately 10% cash on cash, 15% annual equity appreciation (based on 80% LTV with 3% market appreciation), and 10% mortgage principal paydown per year. The pretax IRR is around 35% per year. In year 1 with a cost segregation study, we will get around 45% return from the tax savings on the bonus depreciation. So the first year return, all in with all 4 components is around 80%. Subsequent years the return will be somewhere around half of that.

                Direct real estate investments are high risk, high reward, but if everything works out the returns can be impressive. It took us decades as real estate investors to get to this level. We started small in the early years, and this will be our largest deal to date. This property will hopefully remain in our portfolio until death, when it might pass to our heirs at a stepped up basis. Nevertheless, it may have to be sold to pay the estate taxes.
                That sounds great White Beard. Do you need any more investors?!

                Comment


                • #9
                  Originally posted by Craigslist View Post

                  do you mind sharing any book recommendations that helped you along the way with calculations and learning how to assess a properties investment potential?
                  Online resource: biggerpockets.com
                  Real estate book re: taxes, Amanda Han

                  https://www.audible.com/pd/The-Book-...E&gclsrc=aw.ds

                  Real estate training course: expensive, but can help you grow a deep level of confidence and can help you launch successful real estate investing if you are highly motivated
                  Semi-retired MD Zero to Freedom course

                  Comment


                  • #10
                    Originally posted by White.Beard.Doc View Post

                    Online resource: biggerpockets.com
                    Real estate book re: taxes, Amanda Han

                    https://www.audible.com/pd/The-Book-...E&gclsrc=aw.ds

                    Real estate training course: expensive, but can help you grow a deep level of confidence and can help you launch successful real estate investing if you are highly motivated
                    Semi-retired MD Zero to Freedom course
                    Is your property local and HCOL or did you go further away. If so, any tips for locating and managing property in an unfamiliar market? I am in CA and it’s really tough to find a good rental property here.

                    Comment


                    • #11
                      Originally posted by Hoopoe View Post

                      Is your property local and HCOL or did you go further away. If so, any tips for locating and managing property in an unfamiliar market? I am in CA and it’s really tough to find a good rental property here.
                      You might want to check out long distance real estate investing by David Greene. Good book, though it convinced me NOT to try to be an OOS investor.
                      “Work” is a four letter word for good reason.

                      Comment


                      • #12
                        I believe you can 1031 from one syndication to another if you wish but the intermediary has to be set up before the closing of the sale of the first syndication. It is more complicated than the evergreen funds you mentioned but doable.

                        Comment


                        • #13
                          Originally posted by dennis View Post
                          I believe you can 1031 from one syndication to another if you wish but the intermediary has to be set up before the closing of the sale of the first syndication. It is more complicated than the evergreen funds you mentioned but doable.
                          Typically, you cannot 1031 from one syndication to another. The titling of the sold investment and the swapped property purchase has to be titled the same. There are some exceptions, such as "drop and swap", or the same exact group of owners buying the second property with exactly the same owners and titling, but this is the rare exception.

                          Comment


                          • #14
                            Originally posted by White.Beard.Doc View Post

                            Typically, you cannot 1031 from one syndication to another. The titling of the sold investment and the swapped property purchase has to be titled the same. There are some exceptions, such as "drop and swap", or the same exact group of owners buying the second property with exactly the same owners and titling, but this is the rare exception.
                            I did it. From one syndication I set up and managed to another property. The investment entity was an LLC and the intermediary I used was IPX.

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