Taxes take a sizable chunk out of our income every year. Many people worry about how much they pay in taxes yearly and how to reduce it. The truth is, one easy way to get tax benefits is by earning passive income through real estate syndication.
Several tax benefits are attached to real estate syndication, such as real estate professional tax status, which enables you to make all your real estate income and losses active and decrease the amount you pay in tax on all your income.
When it comes to real estate syndication tax benefits, several factors affect investors’ tax benefits. These factors include the type of entity you made your investment with and the kind of stake you hold. What are the tax benefits attached to real estate syndication? Let’s take a look at them below.
How Real Estate Syndicates Are Taxed
The tax payment structure for the syndicator (general partner) and the investors (limited partners) is different because they perform different syndicated functions.
The general partner is involved in the general maintenance; thus, they pay taxes on certain income from the syndication. More so, the general partner pays self-employment taxes on the money he’s paid in acquisition fees, asset management fees, construction fees, refinancing fees, and disposition fees ( typically one to three percent).
The investors are taxed differently because they’re not as involved as the general partner in the syndication process. Their primary aim of investing is to make passive income, so they get to pay less taxes than the syndicator.
When it comes to syndication costs tax treatment for federal tax purposes, the partnership is treated as having paid the tax regardless of who paid the syndication costs.
Depreciation
Most people consider depreciation the most significant real estate syndication tax benefits. They’re not wrong because depreciation allows you to report a lesser amount in profit than you made for the year. How does this work?
A house depreciates over the years, even with rigorous maintenance, and with it, its value also depreciates. The IRS regards the house as losing money when the house is making income. According to the IRS, rental properties have a lifespan of 27.5 years, while warehouses and commercial properties have a lifespan of 39 years.
The original cost of the house is divided by the lifespan of the house to determine how much you lost to depreciation. So let’s assume you bought a house for $2, 000, 000; you divide it by 27.5 years (for a rental property). The IRS considers that you lost $72, 000 due to depreciation, and it means that even if you made $15, 000 in profit, you don’t have to pay taxes on it.
Bonus depreciation became a concept after the 2017 tax and JOBS cut act. The concept simply means a tax incentive allowing a business to deduct a huge percentage of an eligible assets’ purchase price immediately the investment is made.
No Self Employment Taxes
Unlike other side hustles or modes of self-employment, which have taxable income, the income you make from real estate syndication is not taxable.
While regular jobs and side jobs get to pay Medicare, social security, and self-employment taxes, which total 15 percent of all income, investing in real estate syndication lets you off that hook.
Refinancing
Cash-out refinancing is a great way to create multiple income streams and is just one of the many tax benefits of syndication. Refinancing allows you to borrow against the appreciation of a property to purchase another one. It’s great because this process is tax-free.
This is how it works:
If you bought a property for 1, 000, 000 dollars and renovated the property, thereby increasing its value and earning much more in rent, you’ve effectively increased the property’s value to 2, 000, 000 dollars.
You can take out a mortgage of 1, 000, 000 dollars against the appreciation of the property to fund the purchase of another property. It’s a great way to build your passive income streams.
Capital Gains
The profits you make from selling off property are called capital gains and taxable. However, short-term gains and long-term gains are taxed separately. Real estate syndication falls under long-term gains because you hold the property for longer than a year.
Long-term capital gains are capped at 30 percent, which may seem like a lot until you add it up over the years. Also, it’s a whole lot better than paying, say, 35 percent on your regular job.
The thing with real estate syndication is that the income made from investing in it is way more tax-efficient than most other sources of income.
Mortgage Interest Deduction
Mortgage interest deductions are significant real estate syndication tax benefits to keep in mind when it’s time to pay taxes. With mortgage interest deductions, you can deduct the amount you paid in mortgage interest from your taxable income. It applies to both primary residence owners and real estate syndication investors.
Mortgage interest deductions are highly beneficial to syndication investors who aren’t investing for the long term because most interests in mortgages are paid in the earlier years of the loan. Furthermore, mortgage interest deduction saves you lots of money in mortgage repayment and gives you a tax break.
Summary
There are several benefits of real estate syndication that investors can leverage to decrease their taxes and increase their income. While some of these benefits need to compound over the years before you can feel the impact on your income, some of them are immediately felt.
An added advantage of real estate syndication is the 1031 exchange. You can 1031 your way out of syndication. The significant benefits of a 1031 exchange are deferred taxes and a preferred return banked on a higher investment amount.
With all the tax benefits attached to real estate syndication, it’s an excellent source of passive income. If you’re considering joining a syndicate, go ahead and start your fantastic journey to passive income earning. You can learn more about real estate syndication tax benefits here.
