It is common for real estate syndicators to begin their pitch by discussing the potential benefits of a property’s passive income and price appreciation. These are significant, but they only partially account for the investment’s overall benefits to passive investors. The other less discussed bucket is the six noteworthy tax advantages.
1. Depreciation (Phantom) Expense
Depreciation expense is important for investors in commercial real estate because it provides a tax benefit. The Internal Revenue Service (IRS) allows commercial real estate investors to claim a deduction for the decline in the value of their property over time, known as depreciation. This tax benefit can help offset the property’s taxable income, reducing the investor’s overall tax liability. Additionally, claiming depreciation can improve the property’s cash flow, making it more attractive to potential investors or lenders. Therefore, understanding and adequately calculating depreciation is a critical aspect of investing in commercial real estate.
2. Lower Tax Rate on Capital Gains
Holding onto an investment for extended periods often results in a lower capital gains tax. This is because long-term capital gains, which are gains realized on assets held for more than one year, are typically taxed at a lower rate than short-term capital gains, which are gains realized on assets held for one year or less. In the United States, the tax rate for long-term capital gains is generally lower than that for ordinary income, making it more advantageous for investors to hold onto assets for the long term. However, it’s important to note that capital gains tax rates and rules can vary by jurisdiction and are subject to change. Hence, it’s always a good idea to consult a tax professional for specific guidance.
3. Refinancing
Refinancing is another tax advantage important in commercial real estate because it can provide several benefits to property owners and investors. Some of these benefits include:
Lower interest rates: Refinancing allows property owners to take advantage of lower interest rates, which can result in lower monthly mortgage payments and increased cash flow.
Improved terms: Refinancing can also allow property owners to improve loan terms, such as extending the loan term or changing the type of loan.
Access to equity: Refinancing can provide property owners with access to the built-up equity in their property, which can be used for various purposes, such as making improvements to the property or investing in additional real estate.
Debt consolidation: Refinancing can also allow property owners to consolidate multiple loans into one, making it easier to manage their debt and improve their overall financial situation.
Overall, refinancing can be a valuable tool for commercial real estate investors to improve their financial position and take advantage of favorable market conditions. However, it’s essential to consider the costs and potential risks associated with refinancing before deciding.
4. Mortgage Interest
Mortgage interest is the cost of borrowing money to purchase a property. It is the fee charged by the lender for lending money to the borrower and is usually expressed as a percentage of the loan amount. In commercial real estate, mortgage interest is important because it is a significant expense that affects a property’s cash flow and overall financial performance.
Mortgage interest is tax deductible for most commercial real estate investors, which can provide a valuable tax benefit and reduce the overall cost of borrowing. Additionally, the interest rate on a commercial real estate loan can significantly impact the property’s cash flow, as a lower interest rate can result in lower monthly mortgage payments. In comparison, a higher interest rate can increase the cost of borrowing and reduce cash flow.
For these reasons, commercial real estate investors need to consider mortgage interest when evaluating a property’s financial performance and making investment decisions. In addition, understanding the interest rate environment and negotiating favorable loan terms can help minimize the cost of borrowing and improve a property’s financial performance.
5. Carried Over Losses
Carried-over losses are losses from a previous tax year that can be applied to offset income in a subsequent tax year. In commercial real estate, carried-over losses can be particularly important because they can provide a valuable tax benefit by reducing the taxable income generated by a property.
Commercial real estate properties can generate significant taxable income, resulting in high tax liability for the property owner. However, if the property experiences losses, such as from vacancy or depreciation, these losses can be used to offset taxable income in future years. Commercial real estate investors can reduce their overall tax liability and improve their cash flow by carrying over losses from one tax year to the next.
It’s important to note that there are limitations on the amount of carried-over losses that can be claimed in a given tax year and that these rules can vary by jurisdiction. For this reason, it’s essential for commercial real estate investors to seek the guidance of a tax professional to ensure they are taking advantage of all available tax benefits, including carried-over losses.
6. 1031 Exchanges
A 1031 exchange, a like-kind exchange, is a tax-deferred transaction that allows commercial real estate investors to sell a property and defer paying capital gains taxes by using the proceeds to purchase another similar property. 1031 exchanges are advantageous for commercial real estate investing for several reasons:
Tax deferral: By deferring capital gains taxes, 1031 exchanges allow commercial real estate investors to preserve more of their capital, which can be used for additional investments or other purposes.
Flexibility: 1031 exchanges provide commercial real estate investors with the flexibility to make changes to their portfolios, such as upgrading to a better property, changing location, or diversifying their investments.
Increased buying power: By deferring capital gains taxes, 1031 exchanges can provide commercial real estate investors with increased buying power, allowing them to purchase more expensive properties or make other investments.
Opportunity to defer depreciation recapture: If a property was depreciated for tax purposes, 1031 exchanges could also provide a chance to postpone depreciation recapture. This taxable event can result in a significant tax liability.
Overall, 1031 exchanges can benefit commercial real estate investors, including tax deferral, increased buying power, and greater flexibility. However, it’s essential to be aware of the rules and requirements associated with 1031 exchanges, as failure to comply can result in the loss of tax benefits and other penalties.
Why Tax Benefits Are Helpful to An Investor
The net outcome of the multiple tax advantages is lower taxes for passive real estate investors. Lower taxes result in more payouts, cash flow, and profits for individual investors. Due to this, high-income earners and those looking for tax-saving measures frequently choose commercial investment property.
How is Real Estate Syndication Income Taxed?
It is crucial first to comprehend how real estate syndication businesses function to understand how their money is taxed.
The money is made from rent collected from tenants who inhabit commercial premises. Property taxes, insurance, upkeep, legal fees, and other costs associated with maintaining the property are covered by the money received. “Net Operating Income,” or NOI, is the difference between revenue and costs. If a property has a loan on it – most do – the required debt service is subtracted from NOI, resulting in an amount of money left to distribute to investors.
Investors’ money is distributed, mixed with their regular income, and taxed following their tax brackets. This precise computation is unique to each person and can be difficult. To ensure that it is done correctly, it is always a good idea to contact a CPA or tax expert.
Summary
The capacity of a commercial real estate investment to reduce an individual’s tax burden is one of the sometimes disregarded advantages of such an investment.
Depreciation, operational expenses, the tax rate on capital gains, and 1031 Exchanges are just a few of the methods used to do this. Each of these things helps an investor pay less in taxes in its unique way.
But as an investor’s portfolio expands, these tactics get increasingly complicated. Because of this, it’s crucial to seek the advice of a CPA to ensure that everything is done appropriately.
When it is, a syndicated real estate investment can be a successful method for individuals with high incomes to lower the taxes that need to be paid.
Interested In Learning More?
Farmers Capital Group is a boutique private equity firm that enables agricultural professionals to diversify off-farm into commercial real estate as passive investors. To provide better long-term, risk-adjusted returns for our investors and essential economic assets for the areas we invest in, we concentrate on locating top-tier assets and operators across the nation. For additional information about our investment options, email [email protected]. For more information on what an accredited real estate investor is, click the link!