New investors tend to focus solely on their ROI when investing in a multi-family real estate syndication. However, there are many tax benefits associated with these types of investments, and you will reap a greater reward when you proactively utilize the tax breaks available to investors in multi-family real estate syndications.
If you want to get the most out of your TSP Funds and lessen your tax burden, multi-family real estate is a fantastic option. As a passive investor, you can enjoy the benefits of real estate investing without the headache of having to manage it yourself. To get the most out of your investment, you should understand some of the key tax benefits associated with investing in a multi-family real estate syndication.
This article discusses five tax benefits you should know and how to leverage them to help manage your potential tax liability.
Depreciation
Depreciation is “A reasonable allowance for exhaustion or wear and tear, including a reasonable allowance for obsolescence,” according to the IRS.
Multi-family properties consist of mechanical systems that deteriorate over time due to exposure to elements and general wear and tear. Depreciation allows property owners to mark a percentage of a property’s physical value as an “expense” each year to account for its expected level of deterioration.
This technique will reduce the property’s net operating income, thus reducing the owner’s tax liability. The IRS considers a multi-family rental’s “useful” life to be 27.5 years. The potential savings with depreciation are as follows.
Let’s say you own a multi-family rental property worth $1,000,000. This property would have a depreciation expense of $36,364 ($1,000,000/27.5) per year. This would significantly reduce the owner’s taxable income and save thousands of dollars.
If the property mentioned above generated $100,000 in income in a given year, the tax obligation would breakdown as follows:
- Taxes owed without depreciation = $100,000 x 0.25 (federal income tax) = $25,000.
- Taxes owed with depreciation = ($100,000 – $36,364) x 0.25 = $15,909
With depreciation, the owner of this property will save $9,091 in taxes.
Additionally, there is a way to potentially accelerate the depreciation rate through a cost segregation study.
Cost Segregation
A cost segregation study helps provide additional tax savings by itemizing physical assets into four categories.
- Personal Property
- Land Improvements
- Buildings/Structures
- Land
Depending on how an item is classified, it may depreciate over a shorter period. Items that fall under personal property can depreciate in over five to seven years, while land improvements to parking lots and walkways depreciate over 15 years.
Performing a cost segregation analysis can save a ton on taxes, and due to the complexity of the math involved, it should only be performed by experienced professionals.
1031 Exchange
Another technique that can be used upon sale to defer capital gains taxes (which run between 15%-28%) is a 1031 exchange.
According to section 1031 of the Internal Revenue Code, a property investor may defer capital gains taxes when they reinvest the proceeds in another property. For this to work, several rules must be adhered to.
- The new property must be of equal or greater value to the property sold.
- Both properties are of “like kind.” Meaning they are of the same nature and titled similarly.
- The amount invested in the new property is the same as the profits made on the previous property.
- The new property is identified within 45 days of closing, and the purchase transaction is completed within 180 days.
Passive Income Tax
As a general rule, federal income tax rates are much higher than passive income and capital gains tax rates. This means your tax burden will be lower if you are not considered a “real estate professional.”
A real estate professional spends at least 500 hours working on real estate annually. If you spend fewer than 500 hours working on your real estate investments, you will pay passive income and capital gains taxes instead of steep federal income taxes.
Gifting and Estate Tax Benefits
An added tax benefit when you invest in a syndication, as opposed to direct ownership, is that you may reduce the value of the gift by as much as 30% because, as an investor, you have limited control over the LLC’s interest, meaning less tax liability for the recipient.
When applied correctly, the combined power of these tax breaks can greatly reduce your tax burden. With some knowledge and the right professionals to help, you can leverage these benefits to maximize your multi-family real estate investment.
Investing in real estate while abroad comes with its unique challenges. Passport REI is here to help foreign service members make a meaningful legacy and gain financial freedom. We focus on finding the best multi-family real estate opportunities so you can focus on doing what you do best.
Want to learn more about investing in a multi-family opportunity with us?
Schedule a call so we can learn about your values, experience, and goals. We’ll help guide you through every step of the process to ensure we provide a level of service befitting our nation’s Foreign Service, military, and their families.
