Maximize Your Wealth: 4 Major Tax Benefits of Real Estate Syndications

Mason Equity Partners has raised over $100 million to purchase commercial real estate since our chairman entered the business in 1996.

Investors have many options for where to place their money. Real Estate Syndications have unique tax advantages that other investment options don’t enjoy. For those unfamiliar with heady concepts like “accelerated depreciation” here are the 4 major tax advantages of investing in real estate syndications, broken down with examples:

DISCLAIMER: We are investment managers, not CPAs, so please verify with your CPA based on your specific situation before investing in a real estate syndication

1. Depreciation: Paper Losses, Real Profits

Depreciation is a tax deduction that allows investors to reduce their passive taxable income with “paper” losses from real estate. Simply put, depreciation spreads the cost of a property over its useful life, as determined by the IRS. For instance, if a property is valued at $1 million with a useful life of 27.5 years, the annual depreciation expense would be $36,364 ($1,000,000 / 27.5).

This “paper” expense is not a real cost (there’s no “depreciation” vendor who sends a bill for property wear and tear), but the IRS allows investors to utilize this expense to offset taxable income from passive investments. Passive investment income includes cash flow from real estate, stock dividends, and long term capital gains.

Side note: if you spend a significant amount of time working in real estate then the IRS considers you to be a “real estate professional” (ask your CPA what it takes to qualify for this designation). Real estate professionals are allowed to apply depreciation expenses to ALL of their income, not just passive investment income.

In recent years, the government has allowed for “accelerated depreciation”. Instead of depreciating an asset evenly over 27 years, the IRS has said you can depreciate a larger chunk upfront and then depreciate the balance over the useful life of the asset. In the case of capital investments in heavy vehicles and machinery, the IRS allows you to depreciate 100% of the purchase price of the asset during its first year of useful life. By pushing savings to year 1 rather than spreading them out over time, investors can realize tax savings earlier on, which translates to higher returns on investment.

Depreciation is primarily a tax deferral strategy, rather than a tax reduction one. Depreciation does need to be recaptured when the asset is sold, so this strategy only applies to assets that are held for more than 1 year. As Ben Franklin might say: “A dollar deferred is basically a dollar earned.”

2. 1031 Exchange: Exchange, Defer, Exchange, Defer etc. - Repeat Until You Can't Exchange Anymore or Until You Die

The 1031 exchange, or like-kind exchange, is a strategy that enables investors to sell a property and reinvest the proceeds into a similar property, and defer paying capital gains tax until the replacement property is sold. The replacement property can also be 1031(d), leading to long chains of tax deferral that continue as long as the taxpayer is alive. Upon soon after the taxpayer’s death or the failure to continue executing 1031s, the tax bill comes due. Please note that savvy investors with long investment horizons can 1031 into “opportunity zone” investments. The IRS states that OZ deals pay zero capital gains tax as long as they are held for 10 years. Again, check with your CPA before investing.

For example, imagine you invested in a syndication that purchased an apartment building for $1 million. After a few years, the property appreciates to $1.5 million, and the syndication decides to sell it. Normally, you would have to pay capital gains tax on the $500,000 profit. However, by using a 1031 exchange, you can defer the tax payment by reinvesting the proceeds into another qualifying property.

Please note there are caveats to this, such as all members of the syndicate LLC being required to go into the 1031 together. There are ways around this restriction by utilizing Tenancy in Common (TIC) or Delaware Statutory Trust (DST) structures. These are topics of a future post.

3. Passive Losses: Offset Your Passive Income

Passive losses are tax deductible expenses that arise from passive activities, such as investing in a real estate syndication. These losses can be used to offset passive income, which is the income generated from investments that you're not actively involved in managing. Passive losses include real expenses such as mortgage interest and operating expenses (including property taxes), as well as paper expenses like depreciation and amortization.

For example, if you invest in a syndication and incur $10,000 in passive losses from mortgage interest, property taxes, depreciation, amortization, and other expenses, you can use these losses to offset any passive income you receive from any investment in your portfolio (excluding capital gains from assets held for less than 12 months). Reporting these losses reduces your taxable income and overall tax liability.

4. Invest Through Retirement Accounts for Tax-Deferred Growth

Investing in a real estate syndication through a self-directed IRA (Individual Retirement Account) or 401(k) allows you to take advantage of tax-deferred growth. Any income generated by the investment is not subject to taxes until you withdraw the funds during retirement, allowing your investment to compound tax-deferred without the friction of paying taxes each time you earn income or realize gains on a transaction.

For example, if you invest $50,000 in a syndication through your self-directed IRA and the investment generates $5,000 in annual income, you won't pay taxes on this income until you withdraw it during retirement. This allows your investment to grow tax-deferred, leading to greater long-term returns compared to if you had to pay taxes on this income each year. We can elaborate on more in a future post.

Self Storage Syndications can help reduce your tax liability and maximize your investment returns

Whether you are an accredited investor or just getting started on your investment journey, we welcome you to subscribe for updates and opportunities to co-invest with us. We only send deals that have already been vetted and screened by our management team.

We typically develop $40 million projects or larger, targeting IRRs in the low to mid-teens for our LPs and high teens to mid-20s for our co-GPs. We focus on core MSAs and add value through land-use approvals and density bonuses.

To read about the investment strategies we’ve refined in our 27 years of operation, please click here. If you’re looking to partner, or ready to invest, please reach out to our investments team and let us know how we can help.