The Tax Benefits of Investing in Real Estate Syndication

One of the major attractions of real estate syndication is the variety of tax benefits that investors can leverage. From depreciation to capital gains deferral, real estate syndication offers investors unique opportunities to reduce their tax liabilities while growing wealth. In this guide, we’ll break down the key tax advantages you can enjoy by investing in syndication deals, including depreciation, the 1031 exchange, and other tax-deferment strategies.

Key Takeaways:

• Depreciation reduces taxable income even if the property is appreciating in value.
• Capital gains deferral allows investors to defer taxes when they sell a property.
• 1031 exchanges enable investors to roll gains into a new property and avoid immediate taxation.
• Syndications often pass on these benefits to limited partners, making them a great vehicle for tax-efficient investing.

1. Depreciation

One of the most significant tax benefits of investing in real estate syndication is depreciation. Even though real estate generally appreciates over time, the IRS allows investors to depreciate the value of the property and deduct that amount from their taxable income each year. For syndication investors, this can lead to significant tax savings.

In most cases, commercial real estate (such as multifamily properties) can be depreciated over a 27.5-year period using the Modified Accelerated Cost Recovery System (MACRS). This depreciation deduction helps reduce the taxable income generated by the property’s rental income.

Bonus Depreciation: In recent years, the U.S. tax code has allowed for bonus depreciation, which lets investors deduct a large percentage of the property’s cost upfront. This can be especially advantageous in the first year of investment, drastically lowering taxable income for limited partners in a syndication.

Example: If a property generates $100,000 in rental income but has $50,000 in depreciation, the taxable income would only be $50,000, even though you earned $100,000.

Red Flag: While depreciation is beneficial, if a property is sold at a profit, the IRS may recapture some of these depreciation deductions. This is known as depreciation recapture, and it’s something to be aware of when considering a sale.

2. Capital Gains Deferral

In a real estate syndication, when the property is eventually sold, any profits from the sale are considered capital gains. These gains are typically subject to a lower tax rate than ordinary income, but you can also defer these taxes using smart strategies.
For example, opportunity zone investments or 1031 exchanges (explained below) allow you to defer paying capital gains taxes by reinvesting your proceeds into another qualifying property.

3. 1031 Exchange

A 1031 exchange is a powerful tax-deferral strategy that allows investors to sell one investment property and purchase another “like-kind” property without having to pay capital gains taxes immediately. In a real estate syndication, if the general partner chooses to use a 1031 exchange when selling the property, the limited partners can defer their share of the capital gains tax by rolling their profits into a new property.

Example: If a multifamily property is sold for a substantial gain, a 1031 exchange would allow the investors to reinvest their profits into another property without triggering immediate capital gains taxes. This deferral can continue indefinitely as long as you keep reinvesting the proceeds into new properties.

Red Flag: To qualify for a 1031 exchange, the new property must be of “like kind” and the reinvestment must occur within a specific time frame. If the syndicator does not adhere to these rules, the investors may face tax liabilities.

4. Passive Losses and Tax Sheltering

Real estate syndication investments are typically considered passive income for limited partners, meaning they are not actively involved in managing the property. Passive income rules can offer additional tax benefits because passive losses (such as depreciation) can offset other passive income from other investments, thereby reducing overall tax liability.

Example: If you have a rental property that produces $50,000 in income and you invest in a syndication that has $30,000 in passive losses due to depreciation, those losses can offset your income, leaving you with only $20,000 in taxable income.

5. Cost Segregation

Cost segregation is a method that accelerates the depreciation of certain assets within a property, such as appliances, landscaping, or fixtures. In real estate syndications, the syndicator may perform a cost segregation study to allocate more depreciation to these specific assets, allowing for higher depreciation in the early years of the investment.

This can significantly reduce taxable income for investors in the first few years, providing even more immediate tax benefits.

6. Long-Term Capital Gains

In syndications, profits from the sale of properties held for more than one year are typically taxed at the long-term capital gains rate, which is lower than ordinary income tax rates. This provides a more favorable tax outcome for investors compared to short-term capital gains or income from wages.

7. Opportunity Zones

Another tax-deferral opportunity in syndication is investing in Opportunity Zones, which are designated areas aimed at economic development. By investing in properties located within these zones, investors can defer taxes on their initial capital gains, receive tax-free growth on new investments, and potentially eliminate capital gains taxes altogether if the investment is held for a certain period (usually 10 years).

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