Real estate syndication is attractive to many investors as a means of generating passive income. But that’s not the only reason to consider investing in a syndication. Syndications also offer many tax benefits, notably depreciation. Unlike with earned income, where one must spend money to get deductions, real estate syndication investors get to use phantom deductions like depreciation to reduce taxable income and greatly reduce taxes owed. Here’s everything you need to know about real estate syndication tax benefits.
Life Bridge Capital is a leading real estate syndication company. We offer our investment partners the opportunity to leverage shares of multifamily rental properties into a passive monthly income. Learn More
Earned Income vs Passive Income
Earned income is subject to the marginal tax rate under whichever bracket one qualifies—and the effective tax rate, or the amount of taxes actually paid, remains quite high. Deductions are awarded based on money actually spent, so the only way to reduce taxes paid on earned income is to spend more money on qualified expenses.
Passive income through a real estate syndication investment is still subject to your marginal tax rate, but significant portions of that income can be sheltered with deductions that do not require additional expenditure. This creates a lower effective tax rate, because the marginal tax rate will only be applied to a smaller portion of your passive income rather than the majority of earned income.
Depreciation Acts as a Phantom Deduction
Syndication investors can write off a portion of their income to account for the natural deterioration of the property and its resulting value over time. The IRS considers the lifespan of a residential property to be 27.5 years. You can calculate the depreciation by determining the value of the property, minus the land, and dividing by 27.5.
The 2017 Tax Cuts and JOBS Act accelerates the rate at which investors can claim depreciation and front-load the deductions rather than claiming them throughout 27 years. This is great for real estate syndication investors who will likely only own the property for 5-10 years before the syndication terminates by the sale of the property.
Capital Gains Are Taxed at a Lesser Rate
When an investor realizes profits from selling an investment, that return is known as capital gains. Capital gains are taxed at a lesser tax rate than earned income. Long-term investments, such as real estate held for more than a year, caps out at a 20 percent tax rate. This is a much better tax rate for people in the 37 percent marginal tax bracket, for instance.
Investors Deduct Mortgage Interest
Just as a homeowner can deduct mortgage interest paid on a primary residence, so too can real estate syndication investors deduct the mortgage interest on the property’s loan. Like the depreciation deduction, this is another front-loaded tax benefit that’s great for syndication investors who are unlikely to hold the property long-term. In the early years of a mortgage, most of the payment goes to interest, with the interest portion being less in the future.
Investors Pay No Self-Employment Tax
Regular self-employment that leads to earned income puts people on the hook for both the self-employment and Social Security/Medicare taxes, totaling 15.3 percent. This takes a huge chunk out of profits earned from side work.
By investing in a real estate syndication, investors can earn a monthly income, just like they would from a side project or hustle—but they are not required to pay self-employment tax.
Keep the Investment Chain Going with a 1031 Exchange
In addition to monthly income from rental payments, real estate syndication investors will hopefully realize additional gains in the form of increased equity when the property is sold. While the investors themselves cannot use their shares of the syndication to perform a 1031 exchange, the syndication as a company can, and those savings should be passed on to the investors as well.
Carryover Losses to Keep Future Taxes Low
In the early years of a syndication, when depreciation and mortgage interest are both at their highest, the result may be a surplus of deductions. For the present year, that means no taxes on any income! The excess losses can also be carried over to the following year to get a head start on tax protection for that year.
Make Your Money Work Harder with Real Estate Syndication
Given all the tax benefits of real estate syndication, it is easy to see how this investment method gives higher returns than just the sticker number. Thanks to these breaks, the effective tax rate can be diminutive for investors, and investors end up with more money in their pockets because they don’t have to share as much with Uncle Sam as they might through other passive income opportunities.
Life Bridge Capital is a leading real estate syndication company. We offer our investment partners the opportunity to leverage shares of multifamily rental properties into a passive monthly income. Learn More
